Profit From Energy's Worsening Imbalance With This One Bearish Move

Hopes of a prolonged recovery in energy prices were dashed this week by a series of negative reports that showed how the global oil glut is still with us. Below, we highlight one simple trade that allows you to profit from the growing imbalances in the energy sector.

In its monthly OPEC report released on Wednesday, the International Energy Agency (IEA) boosted its estimates of Iraqi oil production in December to a record high, an indication that Iraq is cheating on the Saudi Arabia-led production accord.

A day later, the U.S. Energy Information Administration (EIA) reported that domestic crude stockpiles (excluding those in the Strategic Petroleum Reserve) grew by 2.3 million barrels for the week to Jan. 13, to a total of 485.5 million barrels. Last week, the EIA reported an increase of 4.1 million barrels in commercial crude oil inventories, exceeding analyst expectations of a 930,000-barrel build.

Energy stocks generally have been on the rise over the past six months, as OPEC production cuts and persistent demand have pushed oil prices past $50 per barrel, the threshold at which energy companies break even. Shares of exploration and production companies, as well as oilfield drilling and services firms, have been bid up to unwarranted heights, as energy investors long starved for growth pile in. The most unrealistic expectations are in oilfield services, which still grapple with weak balance sheets.

However, as the unpredictable Donald Trump assumes the presidency, the many dangers facing the energy sector are starting to become all too apparent. For starters, a strong U.S. dollar and OPEC squabbling will continue to put downward pressure on the energy market. The energy sector, which was buffeted this week, amidst larger concerns about Trump's leadership, may continue their volatility. 

As reflected by Wednesday's IEA report, evidence is mounting that recalcitrant OPEC members such as Iraq already are flouting a production cut agreement cobbled together late last year by OPEC leader Saudi Arabia. Add the economic recession that's widely expected in 2017 and the picture for energy suddenly looks darker.

These unfavorable trends, combined with Trump's arrival in Washington, make the overvalued oil and gas services sector ripe for a fall. You can reap quick profits from this sub-sector's likely correction by selling short the SPDR S&P Oil & Gas Equipment and Services ETF (XES) , the benchmark for the drilling industry.

The top holdings of this exchange-traded fund is a compendium of horrendously indebted oilfield services players: Transocean, Atwood Oceanics, Helmerich & Payne, U.S. Silica Holdings, Halliburton, Patterson-UTI Energy, Schlumberger, Diamond Offshore Drilling, Superior Energy and Baker Hughes.

Schlumberger is a holding in Jim Cramer's Action Alerts PLUS Charitable Trust Portfolio. See how Cramer rates the stock here. Want to be alerted before Cramer buys or sells SLB? Learn more now.

Investors have been yearning so long for a lasting comeback in the energy sector, they've bid up vulnerable energy companies to valuations that aren't sustainable by the fundamentals. For opportunistic contrarians, that's a green light to pounce.

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John Persinos is an analyst with Investing Daily. At the time of publication, he owned none of the stocks mentioned.

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