Oil prices hit a temporary low on August 30 of last year and have rallied considerably since that low with West Texas Intermediate Crude surpassing the $60 a barrel price for the first time since June ’15. Oil has even formed a trendline that connects the lows from the last four months.
Unfortunately the rally has put oil in overbought territory on the daily and weekly charts and it has caused optimism toward the commodity to spike sharply. The Commitment of Traders report from last Friday shows that Large Speculators are net long 632,161 contracts of oil and that is the biggest net-long position of the last three years. The sentiment toward many energy ETFs and energy related stocks have also hit overly optimistic levels in recent weeks.
While oil has been rallying, not all aspects of the energy sector have rallied equally. Exploration and production companies have seen the biggest gains on average with oil services stocks also outpacing other aspects of the sector. The one sub-sector that seems to be lagging the most is the pipeline group.
The chart below compares the returns of the Energy Select Sector SPDR (NYSE: XLE), the VanEck Oil Services ETF (NYSE: OIH), SPDR S&P Oil & Gas Exploration & Production ETF (NYSE: XOP) and the Tortoise North American Pipeline Fund (AMEX: TPYP) since the low on August 30. The green line is the XOP, the blue line is the OIH, the red line is the XLE and the pink line is the TPYP. The XOP gained 26 percent in the last four months of ’17 while the OIH gained 21.1 percent. The XLE represents the energy sector as a whole and it gained 17.6 percent. These are all very respectable returns, but the TPYP only gained 3.4 percent from the end of August through the end of December.
Given the overbought statuses of oil, energy ETFs and energy stocks and the overly optimistic sentiment readings, I would not be surprised to see a pullback in the sector. However, I would look to play the pipeline companies on the short side and here is why. If we look at the daily charts of the XOP and the OIH, we have pretty clearly defined trend channels that would seemingly limit the downside move for the funds.
In the meantime, the TPYP has no discernible pattern to its daily chart.
While I expect the entire energy sector to see a pullback in the next month or s0 and that will wash out some of the optimism, the sub-sector that seems most vulnerable appears to be the pipeline industry.