In late February, energy stocks started to perk up as oil easily moved past the $100 per barrel mark. Rising tensions with Iran were seen as the big factor, but an improving U.S. economy also changed the calculus for many investors. As U.S. consumers start to spend more freely, they have been expected to burn more gasoline. Emerging economies have already been consuming ever more energy, and with little spare global oil production capacity, extra demand from the United States threatened to push oil higher, as was the case in late 2007 and early 2008.

That’s why I decided to add Marathon Oil (NYSE: MRO) to my $100,000 Real-Money Portfolio. That move was aimed at providing exposure to the energy sector, which showed signs of an imminent upward move.



Yet in the last six weeks, a curious trend has emerged. Whether it’s because we’re driving more efficient cars, or $4 gasoline is causing us to drive less, we’re actually seeing a drop in gasoline consumption. And this is setting the stage for an oil glut. In the week beginning March 26, we learned that U.S. stockpiles of crude oil rose 7.1 million barrels last week to 353.4 million barrels, a seven-month high.

Adding insult, many oil producers are also natural gas producers, as the same energy field often produces both energy sources. So as drillers were poking new holes in the ground to profit from $100 oil, they have also been pulling up a lot of natural gas. As a result, natural gas prices are falling even further (with natural gas price futures dropping for the sixth straight session as I write this), and may soon breach the $2 per thousand cubic feet (MCF) level.

Right now, gas producers should be rebuilding depleted reserves after a typical winter drawdown. Instead, there is currently 58% more gas in storage than usual for this time of the year, according to the U.S. Department of Energy. At current prices, look for many drillers to offer downbeat guidance in the coming earnings season.

The fact that crude oil remains above $100 a barrel helps offset some of the pain of plunging natural gas prices. But with crude oil inventories rising, market watchers are increasingly expecting the next move for oil to be down, perhaps to $90 or even $80. Talk of $125 or $135 oil is quickly receding. It’s perhaps ironic that President Obama is getting pressure to release oil from the Strategic Petroleum Reserve (SPR), even though no real shortage exists. Still, any such move could quickly push oil sharply lower.

In light of all this, it no longer makes sense for me to have a very large hedge in my $100,000 Real-Money Portfolio against rising fuel prices. I had bought more than $12,000 worth of Marathon Oil on fears that rising oil would hurt my stakes in Ford (NYSE: F), Alcoa (NYSE: AA) and other economically-sensitive plays. At this point, reducing that hedge by roughly half makes sense if I see impending problems for energy stocks.

I still want some exposure to this stock, however, not only because I think it’s the top industry play, but also because the energy trade could easily be placed back on the front burner again at some point. Perhaps tensions with Iran do boil over, which would lead oil prices to spike much higher, very quickly. Perhaps the energy sector gets hit by a bad hurricane season. Perhaps the steadily-falling rig count finally brings supply down to a level that boosts natural gas prices.

If that’s the case, then Marathon Oil will finally break out to the upside. As I outlined in February, the company’s vast acreage is still underappreciated by most investors. In a more neutral environment in terms of energy supply and demand, Marathon would be poised for significant profit growth. Yet as I noted above, the bias appears titled to the negative, not the positive right now.

Action to Take –> I will be sell 150 shares of Marathon Oil 48 hours after you read this, leaving me with a 200-share position. If oil prices drop, then this stock could end up back in the mid to high $20s, at which point I’d be strongly inclined to boost the size of my position right back up, as the long-term picture remains exceedingly bright.

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