How to profit from the bear market in oil

Risk-managed approach to holdings is key

It is rather remarkable how resilient Western Canadians have been despite the collapse in oil and natural gas prices. Perhaps it’s because the forward market is in contango or simply that the broader North American equity markets keeps testing new highs.

That said, optimism tends to turn into a prayer once your patience runs out and investors, nine months into oil’s correction, are finally starting to wonder about the outlook for oil and natural gas stocks.

Company executives were the first to hit the panic button, as is evident by some of the recent bought-deal equity financings that were done to reduce debt levels even in an era of ultra-low interest rates.

In the end, we can see why they are concerned.

North American oil and natural gas production is defiantly growing despite a large drop in the rig count and collapsing prices. Globally, demand growth has yet to respond to the fire sale pricing and the Organization of the Petroleum Exporting Countries is holding steady with its let-the-market-decide approach.

Overall, it’s rather troubling that a supply/demand imbalance as little as one million barrels per day (a paltry 1.1% of global demand) can slice oil prices in half and stay there for months on end with limited reaction on the demand side.

On the natural gas side, production continues to set new highs even though there has been a reduction of more than 75% in the rig count. Thankfully, a cold winter out east helped keep demand up, otherwise the industry would be in an even worse position fundamentally.

The outlook is overwhelmingly still negative, but it’s important to remember that the sector does cycle and we are now six years into a bear com- modity cycle that is getting a little long in the tooth.

But timing sector tops and bottoms is very difficult, if not impossible, even if most energy fund managers indicate otherwise.

As history has shown, the sector at times can be very rewarding, but equally punishing for those who give into human behaviour such as: having an excessive weighting to the sector because it is what they know; compounding losses due to loss aversion; trying to call bottoms and catching a

Leverage and drilling can be a disastrous combination

falling knife instead; and herd buying at the tops due to return chasing.

Fortunately, there are some ways to manage the risks in the sector while positioning for its eventual recovery.

One of the best ways is to let the management teams of oil and gas companies do it for you.

For example, we like companies that own their own infrastructure and are there-