Oil volatility fails to rouse short sellers
16 May 2017
Short sellers are still largely steering clear of energy stocks despite the resurgence in oil price volatility. IHS Markit analyst Simon Colvin explains
Image: Shutterstock
Oil price volatility came back to life this month when as bumper US production numbers, ongoing questions about the future state of OPEC supply cuts and other technical factors, briefly sent the price of spot Brent crude barrel below the $47 mark for the first time since November 2016.
This selloff brought back memories of last year’s wild swings that sent energy stocks to multi-year lows and driving short interest in the sector ever higher. While the former has occurred to some extent, as evidenced by the fact that the largest energy sector exchange-traded funds (ETF), the Energy Select Sector SPDR Fund (XLE), extended its year-to-date underperformance against the S&P 500 past the 15 percent mark, short sellers are so far staying on the sidelines during this period of volatility. The past month has seen global energy shares register only a 3 percent increase in the sector’s average percent of shares outstanding on loan.
Average shorting activity across all global energy firms has ticked up somewhat from the recent lows set over January, bearish bets are still way off the levels registered during the height of last year’s volatility. In fact, the current average short interest across these 700-plus energy firms whose shares are freely available in the securities lending market, 3.3 percent of shares outstanding, is still a quarter lower than that seen in February of 2016, when oil prices hit their lows.
Median average demand to borrow energy shares, which gives a better indication of how broad the shorting activity is distributed across the sector, is even lower at 1.1 percent of shares outstanding, which is just about the lowest level in over two years.
The varying spread between these two gauges of bearish sentiment in the energy space indicates that short sellers are taking a much more precise approach to shorting the sector, which is a departure from the broad brush employed during the worse of last year’s selloff. This coincides with the narrative on the ground, as well capitalised firms, with profitable operations, rebound strongly while industry laggards, some of which have large debt overhangs, struggle to regain momentum.
Corporate action driving demand to borrow
The current high conviction short plays are also more likely to be targeted for reasons other than purely directional short selling. Corporate actions such as warrants issuance, debt for equity exchanges and convertible bond issuance have made several stocks targets of arbitrage traders looking to take advantage of pricing anomalies thrown off by corporate actions.
One such firm is Premier Oil, the second most shorted oil firm at the moment. Premier recently announced a debt restructuring that saw it issue warrants representing 90 million shares.
Investors have hedged their warrant exposure by shorting Premier shares. Demand to borrow Premier shares has jumped more than tenfold in the past six months to the current 30 percent of shares outstanding. Ironically, this large short interest should be viewed as a vote of confidence in investors’ long-term view of the firm as it indicates approval of its debt restructuring.
Not all good news
Not every energy stock is out of the woods yet, however, as plenty of energy stocks still see more than their fair share of shorting activity. As previously mentioned, the current crop of high conviction shorts is mostly composed of the sector’s laggards as the current 10 most shorted energy names have seen their shares fall 50 percent on average, which is over three time the fall registered by the XLE ETF.
A deeper dive into the current crop of top energy stocks finds a disproportionate number of services firms among their ranks. These firms tend to be viewed by investors as latter cycle plays that perform best when the sector is in a free spending mood, something that is still elusive in the current rally.
Tidewater, the most shorted energy firm at the moment, fits into both categories as the slump has taken the offshore ship operator’s shares down by 97 percent over the past two years. This leaves precious little meat on the short trade as Tidewater’s market cap is currently hovering around $35 million.
Exploration firms, such as Sanchez and Scr Energy, which have 23 and 22 percent of their shares out on loan respectively, make up the majority of the remaining firms among the latest snapshot of the 10 most shorted energy names.
This selloff brought back memories of last year’s wild swings that sent energy stocks to multi-year lows and driving short interest in the sector ever higher. While the former has occurred to some extent, as evidenced by the fact that the largest energy sector exchange-traded funds (ETF), the Energy Select Sector SPDR Fund (XLE), extended its year-to-date underperformance against the S&P 500 past the 15 percent mark, short sellers are so far staying on the sidelines during this period of volatility. The past month has seen global energy shares register only a 3 percent increase in the sector’s average percent of shares outstanding on loan.
Average shorting activity across all global energy firms has ticked up somewhat from the recent lows set over January, bearish bets are still way off the levels registered during the height of last year’s volatility. In fact, the current average short interest across these 700-plus energy firms whose shares are freely available in the securities lending market, 3.3 percent of shares outstanding, is still a quarter lower than that seen in February of 2016, when oil prices hit their lows.
Median average demand to borrow energy shares, which gives a better indication of how broad the shorting activity is distributed across the sector, is even lower at 1.1 percent of shares outstanding, which is just about the lowest level in over two years.
The varying spread between these two gauges of bearish sentiment in the energy space indicates that short sellers are taking a much more precise approach to shorting the sector, which is a departure from the broad brush employed during the worse of last year’s selloff. This coincides with the narrative on the ground, as well capitalised firms, with profitable operations, rebound strongly while industry laggards, some of which have large debt overhangs, struggle to regain momentum.
Corporate action driving demand to borrow
The current high conviction short plays are also more likely to be targeted for reasons other than purely directional short selling. Corporate actions such as warrants issuance, debt for equity exchanges and convertible bond issuance have made several stocks targets of arbitrage traders looking to take advantage of pricing anomalies thrown off by corporate actions.
One such firm is Premier Oil, the second most shorted oil firm at the moment. Premier recently announced a debt restructuring that saw it issue warrants representing 90 million shares.
Investors have hedged their warrant exposure by shorting Premier shares. Demand to borrow Premier shares has jumped more than tenfold in the past six months to the current 30 percent of shares outstanding. Ironically, this large short interest should be viewed as a vote of confidence in investors’ long-term view of the firm as it indicates approval of its debt restructuring.
Not all good news
Not every energy stock is out of the woods yet, however, as plenty of energy stocks still see more than their fair share of shorting activity. As previously mentioned, the current crop of high conviction shorts is mostly composed of the sector’s laggards as the current 10 most shorted energy names have seen their shares fall 50 percent on average, which is over three time the fall registered by the XLE ETF.
A deeper dive into the current crop of top energy stocks finds a disproportionate number of services firms among their ranks. These firms tend to be viewed by investors as latter cycle plays that perform best when the sector is in a free spending mood, something that is still elusive in the current rally.
Tidewater, the most shorted energy firm at the moment, fits into both categories as the slump has taken the offshore ship operator’s shares down by 97 percent over the past two years. This leaves precious little meat on the short trade as Tidewater’s market cap is currently hovering around $35 million.
Exploration firms, such as Sanchez and Scr Energy, which have 23 and 22 percent of their shares out on loan respectively, make up the majority of the remaining firms among the latest snapshot of the 10 most shorted energy names.
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