Oil: Buying Opportunity Of A Generation?

Phil Flynn is senior energy analyst and a futures account executive at Chicago-based The Price Futures Group. He is one of the world's leading energy market analysts and a daily contributor to Fox Business Network, where he provides market updates and analysis. Flynn recently sat down with ETF.com to discuss the latest developments in the oil and gas markets.

ETF.com: What do you make of this week's brief plunge in oil prices below $27?

Phil Flynn: We're being driven this year more by fear than reality. There's no doubt we currently have a glut of supply and have record inventories here in the U.S. We're also worried about the return of Iranian oil into an oversupplied market.

But those facts we've known for six months. We knew those facts when oil prices were $20 higher than they are today.

We're seeing prices go down because of the fear. And the fear, of course, is why the stock market has had the worst start to the year in history. We're getting this global meltdown in confidence.

That said, when we look at the oil numbers, overall demand growth last year was pretty spectacular. China had record demand. We're fearful about China, but it imported more oil last year than it ever had before.

ETF.com: What will turn around this market?

Flynn: What's going to turn it around is a boost of confidence. If we determine the global economy isn't going to fall off the map, then we have a good chance to rebound.

When you have crashing prices, it has consequences. We’re going to see more bankruptcies than we would have seen otherwise. We're going to see a bigger drop in U.S. output, because of this recent price drop.

Companies have already canceled $380 billion of energy projects over the last year. That's going to have ramifications at some point. The only question is, when is the market going to balance? Is it going to be the beginning of this year? Is it going to be later next year? Is it going to take five years, like some people are saying?

My bet is it could happen sooner rather than later, assuming we get some stability in the global marketplace.

If you think we're moving into a global recession, then you don't want to be long oil because the glut is going to last forever. If you, on the other hand, think that these fears are overblown, this could be the buying opportunity of a generation when it comes to oil.

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ETF.com: Assuming we avoid a global recession and the oil market balances, how high do prices go?

Flynn: Well, last time we had back-to-back down years in oil was in 1998/1999, and the next year we were up something like 105%.

Last year we ended around $37. If I'm right, by the end of this year, we should be pushing back toward $60, maybe as high as $70.

I know that number sounds ridiculously high right now. But remember we were at $60 as recently as July, even knowing a lot of what we know now.

ETF.com: What's the best way to play any upside move in oil?

Flynn: You've got to have the courage of your convictions. Right now, you take advantage of the negativity surrounding the marketplace and you can get some bargains on some long-term options.

You can buy December 2016 or '17 or '18 options, and you'll get a pretty good value because a lot of people don't believe oil prices are ever going to go up. So try to take advantage of the low-cost options.

The other way, which gets a little bit more complicated, is try to go long the futures and protect your futures position with options. So if you're a little bit early picking the bottom, you're somewhat protected on the downside, but still have that ability to adjust your position and go long.

I remember one of the best clients I ever had made multimillions trading energy back the last time oil prices were this cheap in 2003. Back then, he was buying $40 calls three years out and four years out.

You have to have that kind of perspective. If you look at the history of oil, traditionally it's been a boom-and-bust industry. Usually in the bust, you create the next boom. Some busts last longer than others, but over time, it starts to go back up.

ETF.com: Turning to natural gas, do you see any hope of a rebound for that fuel?

Flynn: Mother Nature is bearish natural gas. With El Nino this year, we haven't had a cold winter, and we haven't seen a crack in the supply.

The last time natural gas prices rallied was during the polar vortex a couple years ago.

But other than that, let's face it: The summers have been cooler than normal in the United States and the winters have been warmer than normal.

We haven't really tested the market. We have a false sense of security that we have this glut of natural gas that will never be used. That's assuming the weather doesn't change. If the weather changes, you can get a bull market, but we're going to have to have a significant change in the status quo when it comes to weather patterns.

Editor's Note: Related ETFs include the United States Oil Fund (USO | B-100) and the Natural Gas Fund (UNG | B-94).