Option Investor

Bad News Continues to Push Oil Higher 

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Nobody invested in the current LEAP portfolio should be complaining about those higher prices. July crude futures surged to close at $58.50 on Friday and the December contract soared to close at $60.40 and a new all time high. 

OPEC announced after its Wednesday meeting that it was going to raise its production ceiling to 28 mbpd but the news fell on deaf ears. The ten OPEC members the ceiling is supposed to impact are already pumping more than 28 mbpd and prices are still rising. 

I have reported on the real problem before but it is now beginning to make the headlines in the mainstream press. The problem is that all additional production capacity is in heavy sour crude and a product that can only be used by a small number of refineries in the U.S. When you refine (crack) heavy crude you end up with more than 50% heating oil and less than 15% in gasoline and naphtha. This is far less gasoline than is produced from a barrel of light sweet crude. This means you have to refine more heavy oil than light oil to produce the same amount of gasoline. Half the U.S. demand for oil products is gasoline and naphtha, far more than the heavy crude refiners can produce. Heavy crude currently sells for about $10 less per bbl and that is a windfall for those refiners like Valero that can refine the heavy oil. 

Several comments from OPEC members last week helped cause a ripple in prices. The Libyan oil minister publicly said what many of us have been saying for the last year. He said all excess production over 28mbpd would be heavy crude. This may not seem like an overly bright statement for anyone reading my articles over the last year but it was the first time anybody in OPEC had actually confirmed it. This was a shock for anyone still living by the often repeated "oceans of oil" comments. Yes, there are oceans of oil but that ocean is so thick you could nearly walk on it without sinking. This caused one round of price hikes on Thursday. 

There was also a new series of articles, some in the Arab papers as well, that Saudi production had peaked due to major damage in their biggest fields. When oil is pumped out too fast it can cause problems underground including collapsing of the field. Saudi has been pumping at nearly 100% for the last two years in an effort to keep up their oceans of oil image. Like I said earlier this week, there are cracks in that image that will likely become larger and westerners will eventually see the real story as the news leaks out. 

Another problem for oil last week was a sharp drop in oil inventories. Talk is cheap but it does not change reality. Some analysts continue to claim that there is plenty of oil in the system and there is no shortage. Unexpected drops in inventory levels weakens that contention. Eventually all analysts relying on the oceans of oil claims will find themselves paying $3 or more for gas just like the rest of us. However, readers of this LEAPS column will be cushioned from that blow from solid profits. 

The LEAP portfolio is now officially an energy only portfolio. The DJX put suggestion from last week was stopped out on Friday for a minor 45 cents loss. The rising interest rates rescued FNM from a break of the $58 support and I dropped it this weekend. This leaves only energy stocks in the portfolio and I plan on leaving it that way for the rest of the year. We will concentrate on trading/investing in the energy sector until the peak in prices sometime this fall. I do expect a pullback after last week's gains and we will use any pullback to enter new positions. 

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