Playing the oil sector as war approaches...


Junior member
Compared to the week before, the war drums are beating a little louder, the market is a little jitterier and the eruption in the Mideast will occur a little sooner, maybe two weeks or a month or six weeks. The terrorists are still out there, joined now in their troublemaking by the North Koreans.

The consensus of opinion is for a swift US victory that will spark a sharp rise in the DOW and other indexes. But no one can be certain of immediate success or the market’s reaction. Just as every recent headline in the Iraq crisis has undermined any attempt at a rally, every setback on the battlefield, minor or severe, and every image of an American body bag could have the same corrosive effect on stocks.

This is no time to get gutsy about your investments. For the time being, playing both sides of the market—like last week’s option straddle on the Dow “Diamonds” or the NASDAQ “Qubes”—is the only way to go at present, in our opinion.

Going forward, we think it is critical to be informed and prepared for opportunities that may emerge from the fog of war.

Oil is a factor in the Bush administration’s dealing with Iraq. Bush and company want to safeguard world oil supplies and Iraq’s enormous oil reserves will likely be a spoil of war. America will do the dividing of the spoils.

Only 15 of Iraq’s 74 discovered oil fields have been developed and just 125 of the 526 known oil deposits have been drilled. Iraq is now bringing in only $16 billion annually from oil sales—a pittance compared to other OPEC members and the country’s oil production infrastructure is rapidly deteriorating. Output is dropping by about 100,000 barrels every year.

Oil industry experts claim that the picture could change dramatically if the U.S. prevents Iraqi sabotage of its oilfields and puts in place a new regime committed to rapid modernization. If Iraq opens its oil taps, “the whole market will flip from bullish to bearish,” according to Fareed Mohamedi, chief economist at PFC Energy in Washington.

That’s one reason why we’ve long suspected that the price of oil will collapse soon after the successful conclusion of an invasion of Iraq.

The oil producers and retailers like Exxon Mobil (EXE) and British Petroleum (BP) will suffer when the price of crude descends. There also should be some winners in the oil patch, we think. But whom?

Well, an occupied Iraq would likely provide a bonanza for Houston's oil companies and oil-field service firms, analysts say. The country boasts the second-largest oil reserves in the world, but its oil-field infrastructure is in desperate need of repair, and exploration has lagged because of sanctions …

“‘Most foreign oil companies are licking their lips at the prospect of Iraq opening up,’ noted Raad Alkadiri, an energy analyst for the Washington-based consultancy PFC.

The new authorities in Baghdad would probably have to honor many of the contracts signed by Saddam's regime. Indeed, Russia and France could insist upon that in exchange for their support of a war.

BP Chief Executive John Browne has called for a level playing field for companies that have stayed out of Iraq in deference to the sanctions.
And many experts believe there will be plenty of room for U.S. and British firms. A number of analysts pointed to companies like Schlumberger and Houston-based oil-field giant Halliburton as obvious candidates for contracts.

Oil service companies, including American firms, are destined to profit if the war ends in US-led triumph. These are the people who supply and repair the rigs, replace equipment like drill pits, and put out fires. In the current climate of uncertainty, this is the most-confident pick that we can make.

Although Schlumberger (SLB) and Halliburton (HAL) are mentioned prominently in discussions on Iraq, there is no guarantee that they will win the most profitable contracts. There are diplomatic and political hurdles to overcome. For example, Halliburton’s longtime association with Vice President Dick Cheney could help or hinder its cause, depending on how the political winds blow.

Therefore, we think the safe approach is to invest in the Oil Service HOLDR (OIH) from the American Stocky Exchange (AMEX).

HOLDR is short for Holding Company Depository Receipt, it is in the same investment category as the Exchange Traded Fund (ETF), which we have spotlighted many times in the past. Like ETFs, HOLDRs are giant trusts that control millions of shares from dozens, perhaps hundreds of companies. Banks normally manage ETFs; a financial institution, on the other hand, manages HOLDRs. In this case, it’s the Bank of New York.

Like mutual funds, HOLDRs offer diversification. Unlike mutual funds, HOLDRs give owners the same flexibility as if they actually owned shares of stock. Essentially, anything you can do with stocks you can do with HOLDRs—buy and sell at any time during the trading day, sell short, buy on margin. Most are optionable. Like any stock, they are easy to track by following their symbols on the AMEX.

HOLDRs have an important advantage over stocks because most of them are exempt from the “up tick” rule for short sales. For this play, however, we want to go long OIH when the situation in Iraq becomes clear.

OIH has many of the companies that provide drilling, well site management and other products and services for the oil industry. The greatest percentage of it assets are invested in Halliburton (22%), while Schlumberger is No. 3 at 18%. But the HOLDR includes other well-known names like Nabor Industries (NBR) and Baker Hughes (BHI).

Volume for OIH is over 1 million shares, and the action has increased recently. OIH closed Friday at $55.26.

Now is not the time to get into OIH.

The stumbling overall market is taking everyone down with it and your investment could be off 10% before things in Iraq come to a head.

We’d wait to enter OIH when the bombs begin to fall. If, as expected, the indexes rally on war news, this HOLDR will move forward with the rest of the market. Make sure to use a stop loss a few points behind the advancing price of OIH for protection and to lock in profits. We’d be ready to sell out and take home some gains if the war rally proves to be short lived.

The next time to look at OIH is when hostilities have ended and the winners begin to divide the spoils. If repairing and/or expanding Iraq’s oilfields become a priority, we wouldn’t be surprised to see the HOLDR move forward as the companies in the sector are awarded lucrative contracts. It could be slow going if the overall market tone continues to be poor; we’d keep close tabs on our stops.

There are options for OIH, but they are simply too expensive, in our view, for the risk.
Maybe somebody knows something and is running up the premiums on the call contracts.


Posted by Wallman
....... If Iraq opens its oil taps, “the whole market will flip from bullish to bearish,” according to ..............

If Iraq opens its oil taps I would have thought the opposite would happen. Bull markets have always been on the back of cheap oil and bear markets the opposite. Why would an increase in oil supply cause a bearish reaction ?

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