Get Ready for $75 Oil

NEW YORK (TheStreet) -- Oil bulls are increasingly finding it difficult to hide from the avalanche of bearish news from Europe. Almost everyone I know, including myself, hates watching money flow into a gas tank, so following oil prices in a bear market is a labor of love.

Fear resulting from the European crisis is the most influential catalyst driving short-term oil prices lower. Expanding the time horizon diminishes the pricing influence of the European economy; however, I will focus on Europe and the short-term price expectations.

Not all oil is created equally -- the price disparity between West Texas intermediate and North Sea Brent continues to widen. The disparity is influenced by the exchange rate in the euro/dollar currency pair. As the dollar gains against the euro, oil becomes more expensive for Europeans. Higher energy prices create economic headwinds for Europe, while simultaneously exerting downward pressure on the WTI price.


The gale force wind blowing against the European economy appears to grow in intensity, starting with warnings from the European Commission that if Greece is to receive more aid "Greece will therefore have to make substantial additional expenditure cuts in the coming months."

Greece may be able to implement austerity measures (however temporary) large enough to fool the commission into granting another handout. It's doubtful in my opinion much will be accomplished beyond kicking the can a short distance down the road.

If Greece continues its unblemished consistency of spending beyond its means, we can expect the bar tab to be cut off. The inevitable hangover quickly following will most likely result in Greece reaching for 600mg of "exiting the Euro" pain reliever.

Count on Greece to become either a ball and chain or an exceptionally heavy ball and chain on Europe's economy depending on Greece's resolve to stick to its agreements. The current unemployment rate is over 20% and likely to increase to over 30% if Greece leaves the euro.


Spain

As if European leaders don't have enough to worry about with Greece, Spain continues to circle the drain. Faced with a 25% unemployment rate and empty bank vaults, it's hard to handicap which country will fall first. Like dominoes, once one pushes the emergency exit button, expect more countries to follow.

Losing two or three countries from the eurozone is distressing enough on its own; however, the writedowns expected from German and especially French banks may require liquidity injections from the central bank to maintain solvency. Pressure on the equity markets may be mitigated by European Central Bank liquidity; however, the net result is a reduction in relative future spending/GDP growth.

By the end of 2007, the eurozone was the largest trading partner with China, surpassing U.S. In 2007, many Chinese companies not only would quote products in euros, some moved away from pricing in dollars completely.

The European economic slowdown is impacting China enough to continue speculation of monetary easing by China's central bank. On May 5, the central bank lowered financial institutional reserve requirements half a basis point.

While Europeans fret over what shoe will drop next, energy costs in U.S. continue to fall. Oil prices are now at a seven-month low reflecting economic weakness in Europe.

On Wednesday, United States oil fund USO ( USO) traded under $33, a new low for 2012, as TWI oil finished today at $87.49. Oil companies trading at or near 2012 lows this week include Exxon Mobil ( XOM), ConocoPhillips ( COP), Marathon ( MRO), BP ( BP) and the S&P Energy Select ETF XLE ( XLE).

Natural Gas

The Europe situation is why oil prices are falling now; however, regardless of how long it takes for Europe to regain its balance, natural gas tracked with United States Natural Gas ETF ( UNG) within a few years will become the principal influence in North American oil prices. (Read my article about natural gas displacing petroleum.)

Exxon is conducting a feasibility study on exporting natural gas, according to CEO Rex Tillerson during the shareholder meeting Wednesday. While natural gas prices are currently much higher in Asia, China has large untapped natural gas reserves trapped in shale formations. New technologies are driving down the cost of production in natural gas and oil.

Marathon's recent drilling plan for expanded drilling has passed the first step, and Canadian drillers including Shell will soon add new production under $50 a barrel.

Marathon's dividend yield is 2.7% with a payout percentage of 22%. Conoco Phillips' and BP's dividend yield now stands above 5%. Conoco Phillips' shares have fallen in price from an April high of over $75, to $52 today.

With oil stocks dropping in price as quickly as they have, be careful not to fall for "dividend traps." Payout ratios up to 50% to 60% are acceptable as long as revenue and margins are stable. As oil prices continue to drop, and I believe they will, margins will get squeezed along with profits. Earnings misses and dividend reductions are two of the surest ways to move a stock price lower.

Large yields also typically results in lower cost for portfolio protection with options. If you're not ready to sell your shares, look toward buying puts and or selling calls against shares to help mitigate risk.

Expect retests of the 200-day moving average of the XLE ETF near $61, Exxon near $74 and Marathon near $18. USO and Conoco are already trading below the 200-day moving average.

Author does not hold a position in any stock mentioned.

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