ERX - ERX: A Short-Term Trading Product

Summary

• Oil, gas, and energy stocks have declined from their highs. Three reasons why another rally is likely: SPR buying, seasonality, and Chinese and Indian demand.
• Traditional energy company profits are the president's target: Massive profits, share buybacks, and less drilling.
• The administration poses a one-sided argument to stoke populist anger: U.S. green energy policy, OPEC’s rise from the ashes, making capitalism evil.
• ERX gives a big boost to XLE. XLE has held well and remains in a bullish trend.

Samuel Clemens, the great American author who took the pen name Mark Twain, once wrote “ The reports of my death have been greatly exaggerated. ” This quote appropriately describes the recent history of the fossil fuel commodities that continue to power the world.

In 2005 , coal-generated electricity plants created over two trillion kilowatt hours of U.S. power. By 2020, natural gas was powering the plants, with coal demand falling to more than half the level in 2005. The global pandemic caused traditional energy demand to plunge, pushing NYMEX crude oil futures below zero for the first time and briefly to negative $40.32 per barrel as there was nowhere to store the petroleum. Seaborne ICE Brent crude oil futures fell to the lowest price this century at $16 per barrel. Nearby NYMEX natural gas dropped to $1.44 per MMBtu, the lowest price in a quarter century.

Meanwhile, the energy Select SPDR Fund ( XLE ), which owns shares of the leading U.S. traditional oil and gas energy companies and related businesses, fell to $22.88 in March 2020.

As we learned in 2021, the reports of the death of hydrocarbons were greatly exaggerated. The Direxion Daily Energy Bull 2X Shares ( ERX ) and its bearish counterpart ( ERY ) are short-term trading products that turbocharge the XLE’s price action on the up and downside.

Three reasons why traditional energy will rally

On Monday, February 13, nearby March NYMEX crude oil futures closed above the $80 per barrel level for the first time since January 26, 2022. At least three factors point to higher prices over the coming weeks and months:

• Potential SPR replacement: The U.S. Strategic Petroleum Reserve at 371.6 million barrels is the lowest since December 1983. The Biden administration addressed rising crude oil prices in 2022 with unprecedented SPR sales. Meanwhile, the administration has stated it plans to replace the sales when crude oil prices fall to around the $70 per barrel level, which could put a significant floor below the current price.
• Seasonality: Gasoline is the most ubiquitous crude oil product, and the peak demand season is during spring and summer as drivers put more mileage on cars. With the driving season on the horizon in mid-February, the odds favor an increase in gasoline demand and higher prices. Crude oil is the ingredient in gasoline processing.
• Chinese and Indian demand: As China emerges from COVID-19 protocols, energy demand will likely increase. China and India are the world’s most populous countries, with a combined population of over 2.8 billion, over one third of the total number of people worldwide. China and India are not on the same page with the U.S. and Europe on climate change and continue to require more traditional energy.

While there's the desire to replace oil, gas, and coal with alternative and renewable fuel sources, hydrocarbons continue to power the world. From a technical perspective, crude oil prices have not violated the 2022 low.

The chart shows nearby NYMEX futures fell to a $70.08 per barrel low in early December 2022, which stands as critical technical support. Since then, oil prices have made higher lows and higher highs and were near $80 per barrel on February 14.

Oil companies are in the administration’s crosshairs

On October 31, 2022, U.S. President Joe Biden highlighted the decline in oil prices from the 2022 high, the highest level since 2008, and the highest gasoline and distillate prices in history. However, he highlighted the profits at U.S. oil companies , saying, “ One by one, major oil companies have reported record profits, not just a fair return on — for hard work. Every company is entitled to that: A fair return for the work they do or innovation they generate. It means — but I mean profits so high it’s hard to believe. ” He went on to criticize U.S. big oil for “ war profiteering ” and threatened action if they do not “ act in the interest of their consumers, their community, and their country; to invest in America by increasing production and refining capacity—lowering prices for consumers at the pump .”

In his February 2023 State of the Union address before the nation, he again took on the oil companies, saying, “ You may have noticed that Big Oil just reported record profits. Last year, they made $200 billion in the midst of a global energy crisis. I think it is outrageous. Why? They invested too little of that profit to increase domestic production .” The following publicly traded oil companies recorded significant earnings in 2022:

• Exxon Mobil ( XOM ) made $55.7 billion.
• Shell ( SHEL ) reported $39.9 billion.
• Total Energies ( TTE ) profited by $36.2 billion.
• Chevron ( CVX ) posted a $35.5 billion profit.
• BP ( BP ) made $27.7 billion.
• Marathon Petroleum Corp ( MPC ) recorded a $14.5 billion profit.
• Valero Energy ( VLO ) made $11.5 billion.

The world’s leading oil producer, Saudi Aramco (ARMCO), will announce its 2022 earnings in March. China’s Sinopec and PetroChina round out the top-ten list.

In the State of the Union Address, the president suggested share repurchase taxes should be quadrupled to punish big oil for their “ outrageous ” profits. President Biden also threatened other unspecified restrictions on the industry.

A one-sided argument to stoke populist anger

President Biden has crafted a populist message appealing to consumers who have paid through the nose at the pump in 2022 and 2023. However, big oil is not heeding his message and has a compelling argument that explains and contradicts the administration’s position:

• Green energy ramifications: The administration has made no secret that its long-term plans are for zero carbon emissions, with alternative and renewable fuels replacing fossil fuels. The oil companies argue that drilling and increasing production require capital investment in an industry that the administration plans to phase out over the coming years. Moreover, borrowing has become challenging as the leading financial institutions are reticent to lend, given the path toward green energy and away from hydrocarbons. The administration has not been in favor of drilling on public lands.
• OPEC’s increasing power: The green energy initiatives have handed the pricing power in the oil market back to OPEC, the international oil cartel. Since 2016, Russia has become the most influential non-member, with production decisions a function of negotiations between Moscow and Riyadh, Saudi Arabia. Russia has cooperated with production quotas over the past years, and Moscow has made no secret that energy is an economic weapon against “ unfriendly ” countries supporting Ukraine. The leading oil companies argue that their record profits are due to the administration’s climate change policies that inhibit exploration, drilling, and output. The previous administration’s policies led to energy independence from the cartel and Russia as it supported U.S. domestic oil and gas production. On the campaign trail, President Biden pledged to address climate change and phase out fossil fuel production and consumption, handing significant power back to the cartel.

Moreover, geopolitical tensions between Washington and Beijing have caused a leading oil consumer to increase cooperation with OPEC and Russia. And China has been a buyer of U.S. crude oil released from the SPR.

• The definition of capitalism: Business schools have long taught that management’s job is to increase shareholder value and earn profits in a capitalist society. Management for the “ greater good ,” advocated by the administration, runs counter to capitalist ideological principles.

There are two sides to the coin in the Big Oil debate, with the administration and oil companies digging in their heels on each side. The U.S. and global reliance on fossil fuels favor oil companies. Moreover, government tends to move at a glacial pace, and a slim Republican majority in the House of Representatives could prevent the administration’s threats from becoming policy mandates. Meanwhile, many Republicans have objected to the SPR sales as political. They have introduced legislation to prevent new SPR sales unless there's a plan for more energy development on public lands. Another bill would stop sales of the U.S. SPR to China.

ERX turbocharges the XLE

Profits at the leading U.S. oil companies caused the Energy Select Sector SPR ( XLE ) to soar in 2022.

The chart highlights the XLE’s rise from $55.50 on December 31, 2021, to $87.47 per share on December 30, 2022, a 57.6% rise in a market where the S&P 500, the most diversified stock market index fell 19.44%. At the $90.32 level on February 14, the XLE was 3.25% higher in 2023 as the bullish trend is firmly intact. XLE’s top holdings include:

The chart shows that the XLE is the U.S. Big Oil ETF product. XLE is a highly liquid product with over $42.5 billion in assets under management. XLE trades an average of over 16.7 million shares daily and charges a 0.10% management fee.

The Direxion Daily Energy Bull 2X Shares ( ERX ) is the XLE on steroids. ERX’s fund summary states:

ERX’s most recent top holdings include:

ERX uses options and derivative products to create its leverage. At $69.56 per share on February 14, ERX had more than $484.6 million in assets under management. ERX trades an average of over one million shares daily and charges a 0.95% management fee.

The chart illustrates ERX’s 126% gain in 2022 and 4.4% increase so far in 2023. ERX has primarily delivered twice the XLE’s price gains during the periods.

Risk-reward dynamics are critical

Leverage comes at a steep price: Time decay and ERX is a product that will lose value if the XLE declines or trades in a narrow range. Therefore, timing is critical when approaching energy-related stocks with the ERX product. The XLE’s most recent significant rally took the ETF from $68.66 on September 26, 2022, to $94.71 on November 14, 2022, a 37.9% gain. Over the same period, ETX moved from $42.06 to $78.08 per share or 85.6%.

The Direxion Daily Energy Bear 2X Shares ( ERY ) is ERX’s bearish counterpart magnifying the XLE’s price action on the downside. At $27.06 per share on February 14, ERY had over $37.25 million in assets under management. ERY trades an average of 516,568 shares daily and charges a 0.99% management fee.

ERX and ERY are only appropriate for short-term long or short trading positions and require time and price stops. Over extended periods, time decay will erode their value, making them portfolio dust collectors. A clear risk-reward plan is critical for success with ERX or ERY, and the risk must always be a function of potential rewards. While changing the initial dynamics is acceptable when the ETFs move in your favor, moves contrary to initial expectations require sticking to the original program.

I'm bullish on energy-related shares as gridlock in Washington, DC, will likely prevent the administration from following through on its threats. However, bull markets rarely move in straight lines. ERX and ERY are trading products that can enhance results when looking for short-term tops or bottoms in the sector. The reports of the death of traditional energy commodities are greatly exaggerated.

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