Option Investor

Target Hit!

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The price of crude oil sank on Wednesday to $57.40 and hit our $58 target. This is where I expected support to appear but there were many other factors swirling as the week ended. March crude futures roll over next week and there was a long three day weekend looming on the calendar. Also, options expired on Friday. This provided the perfect excuse for those short to bail and take profits and the absence of selling allowed prices to rebound.

We may not have seen the end of this drop but I am betting if $58 is not it then $55 will be. That should give us a firm bottom although volatility could continue for several more weeks. Until traders begin to anticipate summer gasoline demand the prices could wander in the sub $60 range. Typically March brings buying as the cycle traders grab futures contracts ahead of the summer driving season.

We also have another OPEC meeting in March and Venezuela has already gone on record as demanding a production cut to firm prices. I expect several more voices to join the party between now and March.

OPEC lowered their demand growth forecast for 2006 to growth of +1.7 mbpd to a total demand of 84.64 mbpd for 2006. This is only slightly less than previously forecast and the difference is demand destruction from higher prices and from the hurricanes. They also forecast an increase in supply from non OPEC sources of +1.69 mbpd but figures also suggested a slight decline in OPEC output for the period. Yes, their numbers showed production from OPEC members could fall slightly in 2006. Kuwait has said that their biggest field has begun declining and Dubai has predicted their oil will run out by 2016. It is only a matter of time.

Saudi must be taking the decline of their fields seriously despite claims to the contrary in print. Saudi announced they planned to have 80 rigs active at the end of 2006. Since 1982 they have averaged less than 20 per year. In 1982 it rose to 30 but fell to only 4 in the late 80s. Since 2001 the rig count has averaged around 30 and as of January 2006 it is 50. 38 of those rigs were looking for oil and 12 for natural gas. Saudi production capacity is thought to be around 10.5 mbpd and it has remained at that level for several years. This is down from the 12.5 mbpd they produced in the past. Reviewing the 10 OPEC members Indonesia, Qatar, UAE and Venezuela has lost capacity over the last four years. Algeria, Iran, Kuwait, Libya, Nigeria and Saudi have all posted minor capacity gains over the same period. Overall the OPEC 10 have lost 4.205 mbpd of excess capacity since 2002. Production either declined or exports increased. Including Iraq that number increases to -5.275 mbpd. Saudi apparently sees the writing on the wall and is racing to develop additional production from its existing fields by bringing in the 80 rigs. This is the action of a major oil supplier in panic mode. Ignore what they say in public and watch what they do in private. Saudi has a crash drilling program in progress and it is costing them hundreds of millions to drill those holes. If they really had an extra 2 mbpd of spare capacity as they claim in public they would not be racing the clock to drill more wells. Time is running short and I suspect the decline rates of their major fields just took a sudden jump higher.

We added several more plays last week on the sharp drop in oil but we missed several good ones. We missed PBR by 20 cents and BTU by 2.50 and PCU by 1.50. I am leaving them on the list just in case we get another dip in oil prices.

We were stopped out of HOC by 15 cents after an analyst downgraded the refining sector on the same day RIG warned. HOC has rebounded +4 from the drop but instead of just adding it back in as a new play I put it back on the watch list at the price we were stopped. ($56) If we get another entry we will be back in the position for about where we were stopped with no harm, no foul.

Next week the March contract rolls over and the April contract becomes the current month. March closed at 59.88 on Friday and April at 61.29. This suggests we will see some rising prices with the June contract currently at $63 and December over $65. Since this is the period for the demand drop the next few weeks are likely to be the lows for the year.

Natural gas prices refuse to move under $7 despite a very large surplus in storage. Several gas companies were in the news last week and two said they were buyers of reserves at anything in the $6.50 range or lower and would consider it a bargain. Gas prices have dropped so sharply they are running neck and neck with coal for electric generation. As emissions credits expire those marginal coal plants will begin fuel switching back to gas for summer electricity. It is only a matter of time before gas prices begin to rise again and I will look to add a couple gas plays over the next 2-4 weeks.

I am implementing a new process this week. Because of the number of plays in the portfolio I am only going to do individual updates on those with material changes or significant news. Everyone knows why we are playing energy stocks and news on individual stocks is very easy for individual investors to find. If there is no change other than price I will just say "no change" in the play description.

Until the summer ramp begins just keep adding to positions on any significant dip. Keep your stops wide enough to allow for $55 oil and just hope it does not appear unless you are shopping for bargains.

Stop losses, where applicable, will be left VERY loose due to the potential for oil to test $55-$58 range. If the stops are too wide for your risk profile please adjust them accordingly.

Natural Gas Chart - 30 min

Crude Oil futures Chart - Weekly


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