Bullish UGA, Undervalued By $8 (NYSEARCA:UGA)

Via SeekingAlpha.com

This is a continuation of:

Here is a graph of the relationship between gasoline supply, demand, price, and UGA price divided by 10 (so it fits on the same axis as gasoline prices).

Pre-COVID supply, demand, and UGA price correlated on the left of the following graph. Beginning Feb 21 and on Mar 10, the price of UGA (divided by 10, purple) collapse with the Russia-Saudi Oil Price War. UGA dropped below its traditional relationship to gasoline supply (gold) and demand (red).

Currently, UGA is $16.98, about $8 below its traditional pre-March relationship with supply and demand.

Two factors seem highly likely to cause UGA to increase in price to at least its previous relationship to supply and demand ($8 increase):

First, Refiner margins were hit very hard as they were forced to cut production to balance demand cuts during the COVID-19 isolation:

Refiners have an opportunity to improve their margins by slowing the pace of supply to below post-COVID rising demand:

  • April 17 to May 8, refiners did this with inventories decreased by 10.3 million barrels.
  • In the May 15 EIA report inventories increased by 2.8.
  • Refiners balanced increasing supply with increasing demand during the rest of May.

My guess is that UGA will increase to $25 fairly quickly to match its traditional relationship with supply and demand curves now that the Oil Price War is resolved and COVID demand cuts are ending. I am more certain that UGA will increase as a leading indicator of coming oil supply problems:

  • Link: “large U.S. oil drillers spent a combined $1.18 trillion over the past decade, but only generated $819 billion in cash flow from their operations, according to Evercore ISI and the Wall Street Journal.”
  • Rig Count has decreased by 69% in the past year, down to 301. A Rig Count of ~1,000 is required to compensate for the rapid depletion of fracked wells. With negative cash flows, it is unlikely the Rig Count will be increased until oil prices are about the $50 break-even price needed by shale drillers.
  • There is a 4 to 18-month delay between the increase in Rig Count and the increase in oil supply. Supply cannot increase, so demand will have to be reduced by price increases.
  • EIA forecasts demand will exceed supply. This can only happen for the amount of stored resources.
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If EIA is correct that demand will exceed supply for at least 18 months, then it seems likely that gasoline prices will rise substantially to suppress demand to within supply. The price of UGA seems likely to increase to $25 fairly quickly, and then more, if post-COVID demand exceeds supply.

Disclosure: I am/we are long UGA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.