Option Investor
Commentary

Lump of Coal in Your Stocking

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As we head into the holiday season with serious problems in the energy sector the prospect of getting a lump of coal in your Christmas stocking is actually a good thing. With nine weeks left in a very active hurricane season there is still a possibility of a third storm in the Gulf. Considering how badly damaged our Gulf production is a third storm could be the knockout punch. Burning that lump of coal may be the only heat we see by the holidays.

As of Friday afternoon 98% of Gulf oil production was still offline. 79.4% of gas production and 18% of refining capacity. I doubt an enemy attack could have inflicted that much damage all at once. Hurricane Rita damaged the oil sector much more than originally thought with damage to under sea pipelines still being found. Only 60% of existing platforms and 25% of existing rigs report ready to resume at least limited production once the undersea pipelines are repaired.

According to the Minerals Management Service 39 million bbls of oil production has been lost and that increases by 1.5 mbpd. That is roughly the equivalent of two tankers of imported oil every day. It represents 7.2% of our entire annual production and growing. Over 188 billion cubic feet of gas production has been lost representing 5.2% of our annual production at a time when we need to be building reserves not drawing down on them.

Three million bbls of refining capacity are offline and that is why we are not seeing $100 oil based on the loss of the Gulf production. We have more refineries offline than oil production so oil inventories are actually building up as each tanker of imported oil arrives.

This will change quickly. Over 1mbpd of refining capacity should be back online by the end of next week with another 350 kbpd due the following week. This should suck up any incoming oil and put us back in catch up mode. We will still have 1.5mbpd of refining capacity offline for at least 4-8 weeks according to the latest estimates. Higher prices and lack of demand from hurricane damaged areas is also helping moderate the impact of the disaster. EVENTUALLY, that demand will return as the recovery/rebuilding effort gains speed. At the same time there is no reduction of demand across the globe. China grew at +7% in the last quarter and India +4%. Their demand for oil continues to grow while we rebuild.

Make no mistake there is a crisis in energy and while prices appear calm today there is a severe storm ahead. The race is on to repair the damage to the production and distribution infrastructure before the winter demand kicks into high gear. Last summer we saw multiple dollar increases in oil when minor things like a fire on a 50Kbpd platform or a temporary outage in Nigeria or Ecuador. That is 1/30th of the current damage to Gulf production. Once refining comes back online the price of oil is going to rocket as the old refineries bid for light sweet crude.

Natural gas consumption is in the fall weather lull this week. Cooler temperatures mean less need for air conditioning but they are not yet cold enough to require heat. One good cold front and that Indian Summer consumption lull will be over for good. December gas rallied to $15 on Thursday and barely gave up ground on Friday. Profit taking was evident across the sector but it was very light. Since there is no strategic gas reserve the pipelines are running off gas stored locally but those reserves are rapidly shrinking in spite of what the "official" reports proclaim. A sudden cold front could easily push prices to $20 while panicked utility companies rush to get more coal.

That brings us back to the lump of coal. Peabody Energy (BTU) rallied to a new all time high on Friday but gave up ground in the end of day profit taking along with everyone else. Utilities see the handwriting on the wall and are rushing to add to coal supplies before the first cold front hits. While the gas companies will be the racecars for the months ahead, the coal companies, primarily BTU, will be the stealth tortoise that wins the race through steady gains. I suggested you add to your BTU positions last week and those that did were well rewarded. Continue to do so on any dip.

We did not lose any plays this week and picked up two positions on the Monday dip. (PBR, TSO) We missed adding a Valero position by 50 cents at $108 and it hit $117 on Thursday. I am going to add EOG Resources this weekend to round out our portfolio to 10 entries. EOG has 5.4 trillion cubic feet of gas reserves. Multiply that times $15 per thousand cubic feet. It is a scary number and obviously one that has no meaning other than the wow factor. Heck, with the potential for gas to go to $20 and higher over the next few years it might even be too low.

I am afraid I will have to raise all the stops again on the existing plays. It is a thankful job and I am very happy to do it! (grin)

Crude Oil Chart - Daily

Natural Gas Chart - Daily

 

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