Despite oil price rally, short sellers steady bets against energy stocks

As the energy sector turned white hot following a disastrous 2020, short sellers steadied their bets against oil and gas stocks, potentially factoring in the impact of a potential price peak, S&P Global Market Intelligence data shows.

"With oil prices approaching resistance at their 7-year highs and OPEC signaling that it's considering expanding production, some forward-thinking traders may be looking to play a counter-trend move in the energy sector," said Matthew Weller, global head of market research at financial services company GAIN Capital.

As of mid-June, 3.19% of energy stocks on all major U.S. stocks exchanges were held by short sellers, up by 8 basis points from the end of May. While well-below levels from the height of the pandemic, when short-interest in energy stocks surged to 4.63% as oil demand collapsed, short interest in the sector has held steady since the end of February, even as oil and gas stocks have rallied.

Short sellers borrow stock and sell it in anticipation of replacing it later at a lower cost if the share price falls. If the strategy is successful, short sellers profit from the difference between the price at which they sell the stock and the price at which they repurchase.

Short selling roiled equities earlier this year when retail traders pushed GameStop Corp. to sharp increases in response to the heavy speculative betting on the retail game company's pending demise.

Three of the most-shorted energy stocks are ethanol producer Green Plains Inc., which had 20.3% of its outstanding stock held by short sellers as of mid-June, specialty alcohol maker Alto Ingredients Inc., which had 16.17% held by short sellers, and exploration and production company Ring Energy Inc., which had 13.94% held by short sellers. All experienced significant rallies since the start of the year, coinciding with the jump in oil prices and broader gains in energy stocks.

Shares in each of the relatively small companies were declining prior to the jump in oil prices that began in 2020. Short-interest in each company has increased as their shares have gained in 2021.

Green Plains shares, for example, fell roughly 75% during the height of the pandemic, but have rallied nearly 740% since April 2020. Green Plains, which was the most-shorted energy stock as of mid-June, has seen short interest climb from 13.8% to 20.3% since mid-March 2020.

In the first half of 2021, the S&P 500's energy sector gained 42.4%, compared to the overall, large-cap index, which increased 14.4% through June. While energy sector stocks have significantly outperformed all other stocks, the rally appeared to pause slightly in June, climbing less than 0.6% on the month, compared to 2.3% for the overall S&P 500.

While short interest remains highest in healthcare, consumer discretionary and information technology stocks, the energy sector has maintained short interest at the median for all U.S. exchanges, indicating that some investors do not believe that oil prices have much further to rally.

The front-month Brent crude oil futures contract — a benchmark for global oil prices — settled at $75.13 per barrel on June 30, up more than 46% since the start of the year. The contract has traded between $72 per barrel and $76.59 per barrel since June 16.

Analysts expect a significant move in oil prices as OPEC and its allies meet July 1 to discuss a possible deal to raise output after constraining production for months.

While short sellers may believe oil prices may be at or near peak, Eric Nuttall, a partner and senior portfolio manager with investment firm Ninepoint Partners, said these traders could be betting against a generational rally in oil markets.

"I think we are in a multi-year bull market that will see oil make all-time highs in the next two to three years," Nuttall said. "I think the rally has just begun."