Option Investor
Commentary

Oil Levitation

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Oil prices are showing a very good example of levitation by artificial means. While supplies of gasoline and distillates, jet fuel, heating oil and diesel, are continuing to build the price of oil refuses to fall. The culprit is growing political instability in several areas of the globe. Had I foreseen the future we would have a couple more energy positions but these types of events arise suddenly.

The Iran refusal to halt its nuclear ambitions even when several countries offered to give them enriched uranium to produce electricity has catapulted them onto the world stage. Like Saddam the rulers say one thing and then do another and the potential for an eventual conflict appears very strong. That conflict could be more than a year away as the process winds its way through the U.N. committees but the immediate impact was felt in oil prices. Speculators cornered futures contracts and those 330 refineries that actually buy crude were forced to hedge against future needs at higher prices.

Bolivia announced this week that it was going to seize oil and gas reserves owned by international companies but leave other assets like pipelines and refineries in the hands of foreign operators. The president, Evo Morales, said the country would decide the use of reserves and foreign corporations could be partners with the state. This page was right out of the playbook of Higo Chavez in Venezuela. This nationalism of foreign oil is the kiss of death for oil exploration in Bolivia just like we have seen in other countries over the last 60 years. Foreign companies like XOM, COP and CVX hesitate to invest large sums in exploration in countries where those investments can disappear overnight. Investments will go somewhere else instead where companies can control their own fate. Morales said he would not confiscate assets of foreign companies but would take ownership of reserves. This was an olive branch to those firms in hopes some would remain producers under whatever new plan Morales decides to implement. I doubt those companies will be able to remove the assets so the offer is really only a token gesture.

Companies impacted will be Spain's Repsol YPF SA, which holds 35% of Bolivia's 55tcf of natural gas and Petrobras of Brazil, which holds 17%. France-based Total SA, Britain's BG Group PLC, Occidental and Vintage Petroleum also had oil/gas assets in Bolivia. Morales was elected on a platform where he pledged to challenge U.S. interests in his country and forge alliances with Castro. Guess we should not expect anything from Bolivia in the near future or South America in general. With Morales and Chavez leading the revolt the outlook for South American energy exploration looks grim.

In Nigeria being an oil worker is like having a target painted on your forehead. Four oil workers were taken hostage last week in the latest round of rebel violence. Oil production was halted at several facilities and Shell declared Force Majeure on oil deliveries from Nigeria and announced production delays until the situation was resolved. This is especially critical to prices since Nigeria produces the light sweet crude demanded by the majority of global refiners.

The current run in oil prices is begging for a pullback but as we saw last year prices tended to get ahead of reality. In reality Saudi is still producing about 1 mbpd more than current demand and that will eventually push prices lower. You may have noticed that OPEC has been quite this week about production cuts at the end of January. As long as oil is over $60 they will keep the spigots wide open and keep their mouth shut to stay out of the papers. If I had any guts I would be shorting oil today but I learned that lesson several times over the last couple years. Never bet against global politics.

The only forced exit from the portfolio this week was the DJX puts. I had placed the stop at 11025 thinking we could get a little spike over a touch of 11000 before the sellers appeared. Unfortunately that spike took us to 11048 and officially stopped us out of the play. Unofficially I am still maintaining a short bias personally.

I missed an opportunity to add a LEAP put on GM this week when it hit $22.78 on Tuesday. It had been on my target list but the timing was questionable. Last weekend it was climbing sharply on favorable news and I decided to wait another week. That gain has now reversed and a 2007 $20 LEAP Put is now over $6 and nearly 1/3 the stock price. Pass, thank you!

The same was true of MGIC Investment Corp (MTG). I wanted to get a LEAP put with MTG over $70 to go with our LEND position but wanted to get LEND established first and get past MTG earnings on Thursday. Unfortunately MTG fell -$6 from its midweek high at $72.75 after they missed earnings on Thursday and announced an acquisition. I am still going to add it despite the drop.

While I would like to add some additional oil positions it is simply not practical over $64. Oil prices have been moving mostly sideways for a week and the slightest resolution of any of the geopolitical concerns and it could plummet back to earth. Hedge funds may have pushed it to these levels but from the midweek volatility levels they may be having a hard time holding it here. We will be patient and wait.

Patience is a virtue I find difficult to practice!


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