Option Investor
Commentary

Three Days Late

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An unexpected rally in oil prices that continued the bounce began on Dec-27th arrived about three days late for us. While it did favor our remaining energy plays it was too late for BTU, PBR and UPL. Even TIE, which was stopped out along with those stocks last week rallied to post big gains.

BTU stopped at $80.00 rallied to $89
PBR stopped at $68.50 rallied to $79
UPL stopped at $55.75 rallied to $59
TIE stopped at $62.50 rallied to $74

Pardon me while I kick myself for tightening those stops. However, it could just as easily have gone against us and fallen by those same amounts. It is always a judgment call and until I can see the future it will not change.

The oil rally this week is confusing to everyone given the warm weather and adequate supplies. Several traders have claimed it is from hedge funds going back into the market after selling in late December to capture performance bonuses. If you bought at $40 and sold at $58 that represents a significant profit and many hedge funds get to keep 20% to 50% of their gains. Ring the register at year end and put the money back to work in 2006. While that may or may not be the reason for the rally I doubt nobody is complaining. However, if it is the reason then this bounce may end badly.

Negative news keeping the price higher is limited to continued production offline in the Gulf and the chance of an OPEC production cut at the January meeting. If OPEC does announce a cut it normally has a 30-day lead-time or more. Since oil is expected to rise prior to the summer driving season any announced cut would take place just before demand accelerates. While the scheduling of the OPEC announcement would seem out of pace with the calendar it might be just close enough to the rise in demand to push prices even higher and accomplish the OPEC goals without much risk. 403,000 bpd of oil is still offline in the Gulf along with 1.878 bcf of gas.

OPEC also faces the growth in demand from India and China. Revised figures released last week showed China's economy grew by 9.4% in 2004, up +16.8% from the prior number. They also revised the 2005 GDP number to +9.8% with 2006 expected to top +9.3%.

Growth in auto sales is also a continuing problem. China added 4.39 million cars in 2005. The U.S. added +15 million. Add in the rest of the world and we get somewhere in the 25 million range for new vehicles. Even at a very low average consumption rate of 10 gallons per week that amounts to an additional 6.25 mb per week of demand. Allowing for those vehicles taken out of service would probably knock that down to only +5 mb per week or slightly less than 1mb per day of additional demand.

With China's economy soaring they are still consuming oil at a rapid pace. A friend was in Singapore last week and he counted over 70 construction cranes from his hotel window with a view in only one direction. He said skyscrapers were growing in every block.

All of this frantic growth in China and growth at a slower pace in other countries will continue to increase demand but that demand is not going to appear in volume before the summer. Why oil prices are soaring today has nothing to do with fundamentals but more likely money management.

Gas prices fell under $10 for the last two days as unseasonably warm weather continues to cover the U.S. There was a build of 1bcf into storage last week indicating just how little gas was being used. The prior two weeks produced draws of -162 bcf each.

Suncore (SU) announced the production of its one billionth bbl of oil from oil sands in Alberta. The first 500 million bbls took from the opening of the field in Sept-1967 until 1996. The next 500 mb took only 1/3 the time. Suncore is currently producing 260,000 bpd and is in the process of an upgrade to produce 500,000 bpd by 2010 to 2012.

Marathon Oil (MRO) announced that production for Q4 would exceed prior estimates of 350,000-370,000 bpd. End of quarter numbers are going to be closer to 385,000-390,000 bpd.

Rigzone said the rig fleet in the Gulf is going to drop significantly by year-end with six major rigs leaving for other areas. Most are going to Saudi Arabia. Five jackups were officially retired due to hurricane damage and two more are now classified by the Coast Guard as underwater obstructions suggesting they will not be returned to service. The companies that own them are probably waiting until the year was over to list them as unrecoverable so as not to injure year-end financials. More important the Gulf rig count for the high end segment of the rig population is going to decline by about -20% from 34 to only 28 rigs as they are moved to the Persian Gulf. There is currently a 90+% utilization factor of those rigs in the Gulf of Mexico and the reduction of available rigs should increase day rates by +30% to +50% for those remaining. This should be a positive earnings boost for those remaining. Companies involved are Diamond Offshore (11), Transocean (7) and several smaller companies.

I am skeptical of the current bounce despite the gains it produced in the current positions. While I don't want to look a gift horse in the mouth I believe we need to be cautious about protecting our gains.

The transportation puts held their ground as the transportation index posted only a +18 point gain for the week. Higher oil prices and lots of built up profit kept them from joining the rally.

I really enjoyed the bounce in CSC on "rumors of a Hewlett-Packard buyout." I love it when a plan comes together.

I actually went through the motions of buying LEAPS on Google after the flurry of news on Friday. With the $600 2008 LEAPS selling for $71.70 at the close I quickly decided it was a lost cause. Buying GOOG at $465 and selling the LEAP as a covered call would make more sense. Option volume on GOOG is huge but it is all on the cheaper current month options. A March $500 call is still about $20 so "cheap" may be a misnomer.

I am only adding one position, non-energy, this weekend because buying at the top is not my favorite pastime. I was hoping on putting out a shopping list this week after a steep January decline like we had in 2005 but the markets did not cooperate. I still believe the decline is coming but we need to wait for it rather than jump the gun.

Patience is a virtue!


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