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Let's Buy Something

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I think we have reached the point where there are some profitable new plays ahead. They are not necessarily in energy but close. The stars lined up for a couple of plays I have been watching and I think we can add them this week. Those are ESLR, TIE, CAM and VLO. I am going to really load the boat and add LEAP puts on OSTK and KKD.

For the current batch of energy plays the market was kind to us for two days out of five. Not much to get excited about but things are finally going our way.

The new high on natural gas on Friday was quickly sold despite cold weather blanketing the nation. Buy the forecast and sell the storm was the game plan for the week. However, the selling on Friday was not as extreme as we have seen in recent dips. They took profits but dip buyers rushed in to fill the gap. For the most part the gains stuck and we are positioned for the next cold front and gas storage report. Analysts are expecting a draw of -300 bcf from natural gas storage over the next two weeks. This is -10% of gas in storage. Once we break the five year average line it will really get interesting.

OPEC meets on Monday and everyone expects them to continue production at 100% of capacity. The OPEC president has been repeating that suggestion almost daily for two weeks. It is surprising that oil hit $61.50 on Thursday night with his repeated comments trying to restrain prices. Oil follows gas it appears and odds are good gas is going higher. Gas storage has declined for three consecutive weeks with a -59 bcf drop last Thursday. Remember, not only is storage dropping but all available production is being consumed as well. It is a historic fact that we cannot produce enough gas to meet demand during the winter and must depend on 3.2 tcf being accumulated in storage during the fall to offset the shortfall. That storage could fall below 3.0 tcf in next Thursday's inventory report. This year we are hampered by the damage in the Gulf. 2.35 bcf of gas production per day is still offline amounting to a 16.45 bcf production shortage per week. Storage levels are already -45 bcf below last years level and we almost ran out last year. We came very close to dangerous levels of low pressure in the pipelines several times. If this winter is going to be colder as most forecasters expect we could see some really high prices.

The oil companies were in the news a lot this week bragging about their new exploration budgets and stock buybacks. I believe most of this was posturing in hopes of avoiding the several levels of windfall profits taxation currently being considered. Chevron announced a $5 billion buyback, KMG $3.97B, DVN $2.89B and COP $3B.

Conoco announced its CapEx budget would rise +45% to $10 billion as it embarks on a multiyear effort to upgrade its refining capacity. That does not include investments in Russian oil producer Lukoil which Conoco owns 14.8% with an option to go to 20%. While nine refineries will begin upgrades Conoco said the majority of the budget would go toward exploration and production with the biggest chunk destined for the North Sea and west Africa.

Chevron said it was increasing its capital spending by +35% to $14.8 billion in 2006. Like Conoco, Chevron said the majority would be spent on exploration and production. Chevron is expected to earn $14 billion this year, its highest earnings ever. Let's see if you earn $14B and spend $14.8B that does not leave a lot for windfall profits. That does not take into account the announced $5B stock buyback over the next three years.

Devon announced a $4.5 billion budget for 2006 and raised its estimates for reserves by about 425 mb. 2007 production is expected to rise to 232-236 million bbls compared to 216 mb expected in 2006. Drilling to production can run 3-5 years from the first hole so lead times can be extreme.

Speaking of lead times Exxon CEO Lee Raymond had an interesting comment last week. He said, "In the energy industry, time is measured in decades." He said Exxon was involved in a $13 billion project in eastern Siberia that began 10 years ago and is expected to produce for 40 years. "All told, that is more than 50 years for one project," he said. To drive home his argument he added, "Fifty years ago, Dwight Eisenhower was president." That got my attention and drove home the point that all the exploration budgeted above by COP and CVX will not become production until sometime in 2011-2012 and any oil produced then will easily be worth double or triple today's prices. Oil produced in 2020 could sell for $500 a bbl.

Crude oil imports rose to 10.579 mbpd last week and slightly less than last years level for the same period. Production in the gulf is still down by nearly 1 mbpd but demand due to the New Orleans disaster is also down by -750,000 bpd. Refinery utilization passed 90% for the first time since the hurricanes as those operating continue to up throughput and finish lingering minor repairs. The 437,000 bpd BP refinery is making steam to heat up the crackers and should begin production in the next week or so. There is still no estimate for restarting the Belle Chase refinery owned by Conoco. 804,000 bpd of refinery capacity or about 5% is still offline.

The drillers continue to outperform the rest of the sector simply because there are no spare rigs and day rates continue to climb. I have been waiting for a pullback in stocks like Diamond Offshore (DO) and Transocean (RIG) but after their breakout in mid November they have refused to give up ground of more than a buck or so. Very tough to get an entry point. I believe the drillers may survive the Jan-March demand decline since their profits are related to drilling rather than oil prices. There is some correlation simply because many people don't understand but they could be our port in the storm. I am in no rush ahead of the January peak in energy prices.

I believe prices will peak in January even if the country is locked in -10 below weather. From January you can see spring and demand for fill ups on heating oil will begin to decline. The strategy will be to exit any direct plays on oil and gas and spread out into some indirect plays like the drillers on any pullback.

The exception to that could be the two split plays I am setting up this weekend. Those are VLO and CAM. Both split this week after enormous runs. I am betting that buyers will jump on both and the split will give us the premium deflation we are hoping for. Normally there is a period of post split depression but recently it has been absent in energy stocks. I am going to bite my lip and take the entries. VLO at $50, sold! At least that is what I am hoping the retail traders are thinking.

II am adding the KKD and OSTK puts as a matter of timing. In the case of OSTK the retailer has gotten the Q4 holiday spike and that gives us a favorable entry for the Q1 decline. KKD saw a spike up on short covering last week to $6 despite not having filed any financials since Nov-2004. I can't believe it is still listed on the NYSE and feel it is only a matter of time before the death knell rings.

I am also adding Evergreen Solar as a timing play. Solar is not profitable because there is no volume. Without volume it is impossible to get the cost of the technology down to levels where it makes sense. In California the governator is backing a plan to subsidize one million solar rooftops. It comes up for a vote on the 15th. If it passes ESLR should get a major boost from general acceptance of the product and a sharp drop in component costs as manufacturers ramp up production in large quantities. Once California proves it is viable other states should join the party. After all less overall demand for electricity takes the load off the already overloaded electrical grid and generating plants. That means less coal train traffic, less green house gases and less energy stress all around.

The TIE entry is also a timing play. TIMET, Titanium Metals, is the worlds largest supplier of titanium. Uses for the metal are growing daily and TIE is growing with it. Sales increased +58% in the 3rd quarter while product pricing increase by +35% to +66%. Those are very substantial price increases and represents Timet's strength and position in the market place. TIE has gone nearly vertical since early October and a 2:1 split in September. On Thursday and Friday there was a monster sell off of more than $10 as funds took profits. One fund, The Royce Opportunity Fund, was up +1200% in the company since Dec-2003. Just because funds decided to take profits does not mean the business has changed. I am looking at it as a buying opportunity and hope the funds are too busy next week shuffling shares of the NDX and S&P to take more TIE off the table. I believe the selling was prompted by downgrades of several steel companies by Deutsche Bank and Merrill. They downgraded X, AKS and NUE for various reasons and I believe it prompted funds to take profits in TIE as well. Guilty be loose association.

This should be a very volatile week in the markets and it would not hurt my feelings if everyone waited until Friday's close to take these entries. That could very well be the low for the week.

Natural Gas Chart - 60 Min

Crude Oil futures Chart - 60 Min

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