In this issue:

If someone claims the big rally in oil and oil stocks over the last four days is “only” short-covering, feel free to let your attention wander.

Rallies from bear market lows are frequently driven by the short-sellers getting out of harm’s way. “Real” buying tends to kick in later, and that’s especially true for crude, which is traded short and long by speculators otherwise indistinguishable from each other.

On that basis, at least, the rally by West Texas Intermediate from last Monday’s oversold low of $37.75 a barrel to the current $49.20 deserves the benefit of the doubt, even though further gains will have to buck a persistent supply glut.

Despite the violence of the rebound, it was in many ways less the surprising than the extent of the preceding slump, and our lead story explains why crude’s highly likely to recover further in the long run.

What that does not imply is that we should rush back into the riskiest production stocks. The financial state of many of the smaller producers remains precarious and the risk of another downdraft too high, as we also argue.

Fortunately, these are not irreconcilable beliefs. We’re happy to keep recommending the most sound midstream processors that will do OK if energy prices stay low and a lot better than that as the industry recovers. And there’s still nothing wrong with hedging bets on the refiners racking up huge profits in the current environment with stakes in the best oil producers, the ones highly likely to survive this slump and thrive once it ends.

Commit to sticking with a diversified and battle-tested portfolio no matter which paradigm the market picks on a given day.  

Commodity Update

What an incredibly volatile week in the oil markets. After dropping below $40/bbl for the first time in more than six years, West Texas Intermediate (WTI) closed on Aug. 24 at $38.24/bbl. But by the end of the week the price surged. On Thursday, WTI and Brent prices jumped more than 10% apiece, the largest one-day percentage gains since March 2009 for WTI and since December 2008 for Brent. Friday saw a lot of oil bears covering positions as WTI tacked on another 6.3% to close the week at $45.22. The 16% gain on Thursday and Friday was one of the largest two-day gains in the past 25 years. As today’s issue goes to press, the Energy Information Administration announced the U.S. crude production fell more in June than initially projected, and OPEC sent signals that it may be ready to address member concerns about crude prices. These facts helped WTI add another 8.8% on Monday to $49.20/bbl — a wild ride that resulted in a gain of $7.05/bbl since our previous issue. WTI is now up 28.7% in the past week.

Natural gas prices remain soft. The October futures contract settled at $2.68 per million British thermal units (MMBtu), down $0.13/MMBtu since our previous issue. Only one natural gas futures contract — for January 2016 — is presently trading above $3/MMBtu.

In Other News

• Last week a federal auction for offshore drilling leases attracted the least interest since 1986

• The International Energy Agency (IEA) reports that global oil demand is growing at the fastest pace in five years

• The price of WTI dropped below $40/bbl for the first time in more than six years, and then surged to the largest one-day gain over that stretch

• Schlumberger (NYSE: SLB) agreed to buy Cameron International (NYSE: CAM) in a deal valued at $14.8 billion

• Venezuela has asked OPEC to hold an emergency meeting on oil prices

• The Environmental Protection Agency proposed regulations designed to cut methane emissions from the oil and gas sector by up to 45% over the next decade from 2012 levels\

• TV pundit Dennis Gartman turned bullish on crude a week ago Friday just before the price plunged below $40/bbl — citing structural shifts in the market — and then said he was wrong and went back to the sidelines just before oil prices surged by 9%. (This is why I don’t try to time the market.)