Wednesday, June 4, 2008

Trading Pair: First Solar and XTO Energy

First Solar's (FSLR) CEO sells half his holdings in the company, revealed on Monday.
The stock trades at a P/E > 100.
Only product is CdTe thin-film solar panels.
Chart technicals show Aug 2007 trendline broken today, EMA 100 broken today, and double top formation: in other words the stock technicals seem to be screaming "short me".

Currently I have a very concentrated long position in XTO, but I'm thinking of adding a short on FSLR. Should oil prices drop, FSLR will fall faster than a bat out of hell, making it a good hedge for oil production equities. The whole solar sector seems to be well correlated with the crude strip. However, XTO Energy is primarily a natural gas producer. Still, the correlation between NG and CL has been fairly large as of late and XTO has recently added about 10,000 bpd capacity with its Bakken play.

Fundamentally there should be a correlation between FSLR and the NG strip, not FSLR and the CL strip, since solar photovoltaic electric generation largely displaces natural gas based electric generation.

No one has really used fuel oil for electric production in the last five years, too expensive on a dekatherm basis compared to natural gas for marginal electric production, dual fire generation has been on gas since 2002, and anyone who can convert from fuel oil to natural gas has converted.

Hence the widening spread between NG and CL on a dekatherm basis: CL and its derivative, fuel oil, have more than doubled from last year's lows but the substitution effect is no longer present in full, as fuel switching from fuel oil to natural gas has already largely occurred to the maximum physical extent possible. Limited substitution effect = limited ability of CL rise to cause a rise in NG prices.

I'm looking at a $245 entry for the FSLR short, and targeting the 200 day EMA around $205 for exit, in a 2:1 XTO long:FSLR short ratio, beta ratio between the two is 4:1.

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