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Dec 5, 2016

S3 BLACKLIGHT: $5 Billion in Shorts in XOP Oil & Gas and XLE Energy ETF’s

The Spider S&P Oil & Gas Exploration and Production ETF (XOP US) and Spider Energy Sector ETF (XLE US) have once again hit year to date share price highs today and are up 21.6% and 10.8% respectively since the end of October. The XOP ETF is up 43% on the year while the XLE is up 21% on the year.

Long shareholders have been aggressively adding to their holdings in these two ETF’s with over $1.5 billion of inflows since the end of October as the post-election economic environment looks bullish for the energy sector. With OPEC agreeing on production cuts which would decrease the daily oil supply or at least keep it stable and the pro-business and pro-energy Trump administration hoping to increase GDP growth and reduce regulations thereby increasing U.S. fuel demand the energy sector looks poised for extended growth. With increased domestic demand and decreased foreign supply, U.S. producers will step in and fill the production gap with increased fracking and tradition oil & gas exploration. This has been confirmed with U.S. rig counts steadily increasing since the end of July.

Short sellers are of course cognizant of this energy tailwind, but are also seeing an overheated run-up in energy sector companies. Short interest in the XLE and XOP ETF’s are $2.3 billion and $2.7 billion respectively, the two most shorted ETF’s after the Spider Consumer Staples Sector ETF (XLP US) at $4.0 billion.

Short interest in the XLE ETF, whose makeup leans towards mega and large cap companies, is up only 1% since the end of October. Short interest in the XOP ETF, whose makeup is made up mostly of mid and small cap securities, is up $291 million, or 12% since the end of October and up $1.8 billion or 192% year to date.

Short sellers have had a steady presence in the XLE ETF, averaging $2.4 billion for the year with a median balance of $2.3 billion. It seems like the XLE short is more of a core short position hedging out general oil related risk for long and hedged portfolios with its holdings of mostly larger cap names such as Exxon Mobil (XOM US), Chevron (CVX US) and Schlumberger (SLB US). XLE is a general collateral stock borrow, the cheapest borrow cost for the easiest to borrow stocks.

The XOP ETF has more exposure to pure oil & gas exploration and production companies besides the integrated oil & gas goliaths. Holdings such as Oasis Petroleum (OAS US), which is up 107% on the year, reflect the type of overheated stocks of the recent energy sector run-up and the stocks short sellers hope will give back some of their profits in the near term. 2015 average short interest was $1.4 billion and 2016 was $1.7 billion and we can expect short sellers to keep increasing their holdings as the energy sector rises.

With XOP’s market cap of $3.08 billion, the $2.7 billion of short interest is 87% of the ETF’s float. The cost to borrow stock is 1.75% fee and will rise quickly if short interest continues to grow. As the borrow fee rises, we should see more ETF’s created to cover stock borrow needs so although it might get more expensive to short the XOP ETF, there should be ample supply available. 
For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC    
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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