Don’t Pop The Champagne Bottles

Don’t Pop The Champagne Bottles

 The Big Secret On Wall Street, our flagship publication that we publish every Thursday at 4 pm ET. Once a month, we provide to our paid-up subscribers a full report on a stock recommendation, and also a monthly extensive review of the current portfolio, as we share below. Please note: there is a “buy” recommendation and a close-position recommendation in the portfolio review… At the end of this week’s issue, paid-up subscribers can find our Top 3 “Best Buys,” three current portfolio picks that are at an attractive buy price. You can go here to see the full portfolio of The Big Secret.

Every week in The Big Secret, we provide analysis for non-paid subscribers. If you’re not yet a paid subscriber, to access the full paid issue, the portfolio, and all of our Big Secret insights and recommendations, please click here.

Tariffs Are At Highest Levels Since The Great Depression

How To Profit from A New OPEC Price War

Global stock markets have staged an impressive rebound after a series of positive trade announcements that slashed President Donald Trump’s initial tariff rates proposed on Liberation Day. 

While we’re pleased to see the White House walk back a portion of the crippling tariffs announced in early April, we don’t believe the economy or stock prices have fully priced in the cost of the newly imposed tariffs. The International Trade Commission estimates that the net effect of the Trump administration’s tariffs represent an effective rate of 15% to 20% depending on the details of implementation. While an improvement from the initial proposed rates, the levels still represent one of the highest tax rate increases ever imposed on the U.S. economy, and the highest levels since the Great Depression:  

Meanwhile, we continue seeing weak consumer spending dragging down Q1 corporate earnings. The slowdown is broad-based, even hitting the recession-resilient consumer staple companies like Walmart (WMT), Costco Wholesale (COST), McDonald’s (MCD), PepsiCo (PEP), and Procter & Gamble (PG).  Importantly, these trends were in place before the Liberation Day tariff announcements. Since then, consumer sentiment plunged to near-record low levels, while at the same time, inflation expectations have surged to multi-decade highs: 

Stock prices are rallying toward record-high valuations, but if the weak consumer spending trends spill into broader weakness in the economy or corporate earnings, share prices could tumble. 

Our recommendation: if the market declines in April caused you any lost sleep, use the recent recovery in stock prices to increase your cash position. In a recession or bear market, things could get much worse than the blip we experienced last month. As Warren Buffett commented at the annual meeting of Berkshire Hathaway shareholders in early May, when an investor asked about whether the recent market volatility had created any interesting buying opportunities:

It’s really nothing… This has not been a dramatic bear market or anything of the sort.” 

More important than listening to what Buffett says, watch what Buffett does. He was notably not a buyer during the brief April downturn, even as retail investors poured into the market with the largest stock buying spree on record among individual investors. Instead, he continued building Berkshire’s war chest of cash for when the real opportunities strike. We suggest doing the same. 

Meanwhile, there is one major development that could unleash buying opportunities in the energy sector. That is, the recent decision by Saudi Arabia and the OPEC+ cartel to open the floodgates of new oil production onto an already-oversupplied market – pushing down the price of oil. 

The Growing Risks Of An OPEC Oil Price War

On May 3, the OPEC+ cartel – which consists of the original 12 OPEC members plus 10 additional oil-producing countries – announced a production increase of 411,000 barrels per day (B/D) starting in June – nearly three times the 138,000 B/D increase the group had previously agreed to, and that’s on top of the 500,000 B/D in production increases the group agreed to in April and May. 

So in the span of three months from April through June, OPEC+ will add nearly 1 million B/D of oil production. This production deluge comes at a time when the oil market is already struggling with excess supply, with prices down 50% from $120 per barrel in 2022 to around $60 today. And it raises the spectre of an all-out price war in the global oil market that could crush prices… as one Wall Street analyst commented in the wake of the May 3 OPEC+ decision: 

OPEC+ has just thrown a bombshell into the oil market.”

Saudi Arabia, the cartel’s de facto leader, is instigating this aggressive boost in output into an already-weak market. The consensus view among oil analysts is that the Saudis have grown weary of maintaining production cuts while other OPEC+ members, and the U.S. shale industry, gain market share at its expense. And with the Saudis now fighting for market share rather than trying to prop up prices, we are seeing similarities with the past two price wars that sent prices into a tailspin. 

The last time the Saudi’s launched a price war against the shale industry was over Thanksgiving weekend in 2014. Then as now, the market had become oversupplied due in large part to new high levels of U.S. shale production. Prices had dropped from over $100 per barrel in the summer of 2014 to around $75 by late November. 

Analysts and other OPEC members expected the Saudis to coordinate a production cut to boost oil prices at the cartel’s November 2014 meeting. Instead, the Saudis pushed the group to maintain its current production rate despite the growing signs of oversupply. Oil prices crashed by $10 per barrel the following trading day, and then fell another 50% over the next 18 months. In September 2016, the Saudis reversed course, announcing OPEC’s first coordinated production cut since 2008, slashing output by 1.2 million B/D. 

Despite a record surge of bankruptcies in the shale patch from 2015 to 2016, the industry recovered and went on to set new highs in production, gaining more of the global market share. Shale’s resurgence kept a lid on prices, which remained below $60 per barrel heading into the next price war in 2020. This time, the Saudis had trouble convincing the rest of its OPEC+ members to cut production more aggressively in the face of the COVID-19 demand shock. 

At an OPEC+ meeting in early March 2020, Russia refused to agree on the scope of production cuts the Saudis proposed. In response, the Saudis reversed course and announced a record 2.6 million B/D production increase. The move sent oil prices into a nosedive that culminated in the infamous plunge to negative $40 per barrel in April 2020.   

The record rout in crude prices marked a quick end to the Saudis price war. Later that same month, OPEC+ agreed to the largest ever production cut of 9.7 million B/D, in an attempt to stabilize the market. 

The recurring pattern through all of these attempts at bullying the market into submission is clear: OPEC can only manage fleeting market share gains, before ultimately surrendering more control of the market to U.S. shale drillers. That’s because each price war is ultimately met with a market crash, which then forces OPEC to cut production to bring the price back up. And these production cuts then open up more of the market for shale drillers to take. That’s how over the last dozen years, OPEC has given up nearly one-third of its global market share, which has fallen from 42% in 2012 to just 33% today: 

And over that same time period, the relentless growth in shale production has propelled the U.S. into the single largest source of global oil, doubling its market share from 8% in 2012 to 16% this year: 

Thus, U.S. market share gains versus OPEC countries show no sign of ending. And with the Saudis once again frustrated with their ever-shrinking slice of the pie, they seem intent on flooding the market to lower prices and force U.S. shale drillers into submission.

We can’t know with any certainty how aggressively the Saudis will open the production floodgates in the months ahead. But history tells us how this story ultimately ends: with short-term pain for U.S. producers, followed by long-term market share gains for these same players. 

So, what to do? We suggest creating a shopping list of the best energy companies leading America’s shale revolution, in case this turns into a full-blown oil price war. History shows that fortunes can be made buying shares in these companies during the depths of an OPEC-led price war. 

The key is to avoid the marginal businesses that will get wiped out in a low price environment, and only buy the absolute best businesses, and those with the staying power to survive a bear market. And by far, the best and most resilient businesses in the shale patch are oil and gas royalty companies. 

The key advantage of royalty companies is that they don’t carry the burden of capital expenditures or operating expenses that exploration and production companies do. Instead, they lease out the land upon which these companies drill, earning a percentage of the production on their land, without incurring any of the costs from drilling holes in the ground. 

That’s how royalty businesses can generate positive earnings and cash flow even when prices crash. Most of the time, these businesses trade at rich valuations… but on those rare occasions when prices crash and energy stocks get sold indiscriminately, they can plunge along with the entire industry and eventually be bought at bargain prices. 

Consider the case of our number-one oil royalty company, Texas Pacific Land (NYSE: TPL). During the depths of the two prior OPEC price wars, TPL shares collapsed by over 50% from their high. However, investors who bought then went on to earn world-class returns, reaping a 39% compounded annual growth rate (“CAGR”) from November 2014 and a 54% CAGR from April 2020. The long-term gains in Texas Pacific have been so incredible since those periods that these prior price declines barely register as a blip on the stock chart:

In this week’s issue, we’re revisiting the key energy names in our portfolio that are exposed to the potential threat of an OPEC price war. This includes two oil-focused companies that could take a short-term hit, and another that’s poised to become an immediate winner from a collapse in oil prices – a stock that’s gained 18% year to date, and one we believe has a lot more upside ahead. 

In the meantime, we’re bracing for more volatility among oil-related stocks across the board. One of the best ways to capitalize on price fluctuations is through options trades that can transform volatility from a source of pain into an opportunity.  

This includes the trade we recently detailed in shares of Viper Energy (Nasdaq: VNOM) 

These are the kinds of opportunities we’ll be focused on in The Trading We recently released a video detailing everything you need to know about this exciting new product, where we’re putting our best ideas to work in a live $100,000 trading account. Click here to get access.