In this issue:

Here’s how last week went in the energy space. On Labor Day, oil prices fell nearly 4% on worries about Chinese growth and ample supply from OPEC, the North Sea and elsewhere.

On Wednesday, a reporter attending the Barclays Energy Conference featuring many of the industry’s heavyweight described the mood among participants “like a funeral.” Or, as Anadarko Petroleum’s (NYSE: APC) CEO put it in his presentation, “It’s raining, and it’s going to rain for a long time. We’re all going to get wet. A few will drown.” Crude fell 4% again, giving back Tuesday’s gains.

Finally, on Friday, Goldman Sachs dropped its 2016 forecast for West Texas Intermediate from $57 to $45 a barrel, warned oil prices could drop to as little as $20 if output doesn’t drop quickly enough, and downgraded the MLP sector for good measure. The Alerian MLP Index dropped 3%, bringing its losses to more than 6% in September and 37% over the last year. Crude fell almost 3%, reversing the bulk of Thursday’s gain.

With all this going on, why are we worrying about refiners and gas producers? Because market prices don’t move based on current fundamentals. They move based on changes in  investors’ expectations.

With expectations and sentiment in the oil patch so comprehensively depressed, resilient demand and moderating shale supply could well produce meaningful upside for oil prices and oil stocks over the next year.

In contrast, expectations for refiners are sky high based on their recently strong margins and record domestic demand for gasoline. And that leaves the sector vulnerable to disappointment as the tailwinds that have propelled refining stocks higher begin to abate. That’s why we’re recommending that subscribers take the profits and run despite the major contribution of refiners to our portfolios’ outperformance in recent years.

We have no such qualms about the Canadian gas producer Peyto Exploration & Development (TSX: PEY, OTC: PEYUF) because investors’ expectations for it appear reasonable, in line with the stock’s resilience and management’s outstanding track record. In fact, as our screen shows, Peyto remains one of the lowest cost gas producers in North America. Its low costs are helping to ensure that Peyto’s current 4.5% dividend yield is coming out of its recent profits rather than new borrowing, as is the case with almost all the oil supermajors.

Of course, we can’t be sure that refiners will soon disappoint, any more than we can guarantee that oil will surprise to the upside. All we can do, all any investor can do, is to secure the most advantageous odds. And right now market odds clearly favor the thoroughly soaked oil and gas producers and their ailing midstream partners over refiners that have seldom had it so good.                 

Capital gains go to those who can anticipate the market’s sentiment shifts. Those who extrapolate the recent past into the future tend to end up with the consolation prize of a tax deduction.

Portfolio Update

• Alon USA Energy (NYSE: ALJ) dropped from Aggressive Portfolio
• CVR Refining (NYSE: CVRR) dropped from Aggressive Portfolio
• Western Refining (NYSE: WNR) dropped from Aggressive Portfolio
• Delek Holdings (NYSE: DK) dropped from Growth Portfolio
• HollyFrontier (NYSE: HFC) dropped from Growth Portfolio
• Marathon Petroleum (NYSE: MPC) dropped from Growth Portfolio
• Tesoro (NYSE: TSO) dropped from Growth Portfolio
• Valero (NYSE: VLO) position halved in Growth Portfolio  
  

Commodity Update

The volatility in crude has settled down a bit as prices gave up some of their recent bounce. Since our previous issue, West Texas Intermediate (WTI) fell $4.57 to $44.63/bbl, while Brent crude retreated to $48.14/bbl. Natural gas prices remain about the same. The October futures contract tacked on a penny since our previous issue to close at $2.69 per million British thermal units (MMBtu).

In Other News

• Indonesia is rejoining OPEC after a seven-year absence

• Former vice-presidential candidate Sarah Palin said she would like to be Secretary of Energy in a Donald Trump administration

• A House subcommittee voted this week to lift the 40-year-old ban on exporting crude oil

• Royal Dutch Shell said it’s canceling its Westward Ho pipeline project that would have moved 900,000 bpd of oil from Louisiana to Houston

• In a pattern that is becoming familiar, the Energy Information Administration (EIA) again made downward revisions for recent U.S. crude oil production, and projected oil output to fall by 800,000 bpd over the next year

• The International Energy Agency predicted in its monthly Oil Market Report that non-OPEC oil supplies will fall to their lowest level in 20 years next year. Meanwhile, Goldman Sachs continues to predict oil could fall to as little as $20/bbl (recall that in 2008, as oil was nearing its peak, the investment bank predicted a price of $200/bbl.)