Option Investor

Ready for Fall

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Despite oil hitting another new record at $68 there was little confirmation from the individual stocks. The massive drop in oil at Friday's close from near record levels shows how quickly sentiment can change in what many consider as a bubble market.

Adding to that confusion was some I generated myself by posting incorrect entry triggers on some watch list stocks last weekend. I had so many updates to do it appears I got my fingers crossed. Chesapeake and Arch Coal were incorrect. I am adding Chesapeake this weekend using the Friday price to correct that problem. Arch Coal was not triggered and I will expound on that in the watch list commentary.

As we draw near to the end of summer and the end of the peak driving season the demand for gasoline will ease. Gasoline prices will ease but they never return to "normal". Demand will begin to rise for heating oil, jet fuel and diesel. Refiners will undoubtedly decline after Labor Day but that should be considered an entry opportunity. Once the conversations shift to the shortages/prices of the other distillates they should move back to new highs. Refinery capacity is running at 100% and it makes little difference which product they are producing. There will also be some refinery outages as they switch over to the winter products and formulas.

As I said in the Option Investor wrap I think $68 may be close to a short-term top in oil unless hurricane Katrina does some serious damage in the Gulf. The demand lull will take the pressure off prices until the next story appears. Traders fell $70 is a given but $75 is seeing a lot more skepticism. This is good as it prompts traders to short the highs thinking we are at a top. If those highs are exceeded then the short covering sends it even higher.

We had the normal oil related stories of supply disruptions from fires, breakdowns, terrorists, civil unrest and assorted political stories. Overriding all of them for me was the bid by another Chinese oil company to acquire oil assets. CNPC bid $55 for PetroKazakhstan in a $4.5B acquisition. However, the story does not end there. India's Oil and Natural Gas Corp (ONGC) was evidently the losing bidder and they are weighing a higher bid. China's CNPC has already said they have the option of matching any higher bid. The stock traded up to $55.58 on Thursday in anticipation of ONGC bidding higher or an as yet unnamed third party making a higher bid. It pulled back slightly in Friday's oil sell off but the anticipation is still there.

The key point here really revolves around the comments surrounding the bids. Both India and China said they need to "lockup" reserves well in advance of their actual need. I have mentioned this a lot in the past that it is no longer a game of who sells oil by the barrel on the daily market but who controls the actual reserves and plans on keeping them for themselves. There is no reason to go global shopping for reserves if you are just going to sell them on the open market like everyone else. If there were only 100 gallons of gas left in your town you would not buy them just to resell them to the next guy at a higher price. You would buy them to put into your own car. If it only burns 10 gal a month you would save the rest, NOT RESELL IT. This is where I believe everyone else is missing the boat. It is not just a game between resellers. It is a life or death game of critical commodity acquisition. Oil is the life blood of a nation and those without it ten years fro now are going to be at the mercy of those that have plenty. It will not be a question of price once supplies begin declining but a question of desperation.

Because PKZ is a Canadian firm primarily doing exploration and production in Kazakhstan there would be a limited number of bidders and it is not a national security event for Canada. They said there will be no effort to block the bid.

It is only a matter of time before India or China announce their next acquisition because both of these oil starved countries are well ahead in seeing the future. Whether Peak Oil is one year away, five years or even ten, it is coming and we will see a major change in global hostility.

The game for us is to identify those companies that will either be potential targets or profit substantially from the rise in oil prices.

We were triggered on several breakout events on Monday when oil hit new highs for the first time. The event spiked oil stocks out of their ranges and the instant retracement of the crude price started stocks back on the road to decline. Even the gradual rise back to $68 on Friday was not able to breath life back into many issues. Fear of the weekend and fear of no hurricane damage created a lingering weakness that accelerated into the Friday close. That means we are underwater in some of our new entries after only a week.

Because of the potential instability in oil after Labor Day I am not adding any new watch list items and we will nurse our current positions until a new trend appears. If anything I expect another serious dip in price next week if Katrina turns out to be a weakling. It will be portfolio managers trying to book some profits as August closes.

Check each position for potential put insurance entries.

October Crude Chart - 90 min


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