Know that sounds like heresy but after stalling at just under $70 all week we could be setting up for a fall. $70 is very strong resistance on the May futures contract and represents the post hurricane high from September and the retest back in January. The close at $69.45 on Thursday came on a short covering spike just minutes before the end of trading. I was watching the activity on a short term chart all day Thursday and it looked like traders were simply scared to be short over the long weekend. I would love to say a breakout was imminent based on the three week uptrend but the three day stall at just under $70 was short on conviction.
I believe we better be ready for a bout of profit taking just in case we are unable to break $70 on Monday. Next week is the final week of trading for the May contract and we are sure to see some expiration volatility. The new contract is June and it shows much more conviction than May. The June contract closed at $70.82 on Thursday, the all time closing high for that contract, although $71.15 was the intraday high. The June contract appears ready to make the breakout leading me to wonder if the stall on the May contract is simply due to traders leaving ahead of expiration next week. Time will tell.
On Wednesday the IEA raised its estimates of demand for 2006. They said OPEC will have to pump more oil to cover a shortfall from Russia, Nigeria and Iraq. Higher than expected consumption in the Middle East and Asia Pacific prompted the IEA to raise its estimate of world demand to 85.1 mbpd up +300,000 bpd from their prior estimate. They claim China has not been the growth engine in the area but the surrounding nations. However, a report issued on Thursday said China's GDP for Q1 showed growth of +8.5% on top of a growth explosion of +9.9% in 2005. China is expected to cool to +7.5% by year end but that is still very strong. China said investments in fixed assets rose +26.4% in Q1 on top of +25.7% growth in 2005. This explosive growth in China is impacting all its neighbors and the entire Asian region is increasing its consumption of energy. Before the year is out I expect the IEA to raise its estimates again.
The IEA said oil production growth outside OPEC would slow to growth of only +1.15 mbpd due to outages in various countries. The IEA said non-opec production could fall short by -300K to -400K bbls per day. The IEA said OPEC will have to produce an additional +400,000 bpd to compensate for the slowing production from elsewhere on the globe. Russia, the worlds second largest oil exporter, will fall short of expectations for the next four years according to the IEA. Bad weather, mechanical problems, start up delays, fires and strikes have affected Norway, Argentina, Brazil, Ecuador, Bolivia, Peru, Canada, India, Vietnam, Sudan, Chad and Yemen. Rebels, insurgents and terrorists have slowed production in Iraq and Nigeria. Venezuela, Bolivia and Ecuador are nationalizing their oil fields and that is slowing outside investment. Mexico said last month that its biggest field was declining at the rate of -7% per year. To put it mildly there is trouble brewing the world over and there is little to be optimistic about for future production gains.
With a little more than six weeks before hurricane season begins again there is still more than 300,000 bpd of crude offline in the gulf. You would think all of these global production problems would have oil on a rocket ride higher but the fly in our soup is the huge inventory of crude in the U.S. Crude inventory levels are at a seven-year high at present. This is due mostly to a very strong refinery maintenance schedule and the need to upgrade some components to make lower emission diesel. Refinery utilization fell again last week to 85.6% an inputs (oil) to refineries was down -3.7%. Gasoline inventories are below last years levels and the combination of the above means higher gasoline prices ahead. I paid $2.69 in Denver on Thursday and I can easily see $3.00 not far ahead and we are not even in hurricane season yet.
The picture I painted above shows problems in almost every part of the production to consumption chain and a clear reason for oil prices to move higher due to rising demand. I do believe that will happen but we could have a sharp bout of profit taking next week. It would be dip buying time for me and I would look for prices in the $68-$69 range on the June contract (CL06M) for support. That could dip as far as $67 but I am not going to wait for that bell to ring. $68 would work for me. We still have an outside chance of a short squeeze as the May contract closes. We have seen it several times recently as contracts expire. Shorts are counting on that seven-year high in crude inventories and thinking a glut has formed. The geopolitical problems are keeping the pressure on and not giving them a dip to exit on. If we do see a short squeeze toward the end of the week I would expect the first week of the June contract to be the dip. We have not had a real dip since mid March.
The rally to $69.50 last week took us out of some more covered calls and some exits were not pretty. The rally from the March 20th lows was stronger than I expected due mostly to the Iran problem but the bottom line was some ugly stop losses on some of the covered calls. Keep the faith we will try another series to lower our cost as the summer progresses.
Natural gas surprised everyone with a +55 cent jump on Friday back to $7.20. The December contract roared back to $10.58 and caught all the shorts in the gas market flatfooted. Everybody was thinking glut but gas inventory levels rose much less than expected for the week. Traders were expecting nearly a +30bcf build and got only +19 bcf. Total gas in storage rose to 1714 bcf and +63% over the five-year average BUT this is a sharp decline from the 3282 bcf high we saw back in November. It is almost a 50% decline. It should rise some before the summer cooling ramps up electrical demand but not that much. It is very possible we could have some shortages this summer since the weather has started off a lot warmer than normal.
The bottom line for energy stocks is simply continue to hold them and buy the dips to add to your portfolio. The conditions I described above are terminal. Slowing production, increasing decline rates and rising demand will eventually produce a catastrophic event on a global scale and 2007 is my target date. We want to be fully invested for every up cycle, summer and winter, and take advantage of the spring dips like we did this year.
I would caution everyone that earnings for many energy stocks are next week. If we get a few disappointments, earnings that did not reach the overly optimistic targets set by analysts, we could see a wholesale drop across the board. If you have some nice profits to protect I would raise the stops just to be careful. I am not doing that to the portfolio since this is a long-term hold scenario but I would be careful on an individual basis. Conversely, if profits beat estimates we could see another leg up appear.
Check out Headwaters this week. We exited the LEAP last week for a breakeven. Sure glad we did!
May Crude Oil futures Chart - Daily
June Crude Oil Futures Chart - Daily
December Crude Oil Futures Chart - Daily
May Natural Gas Futures Chart - Daily
December Natural Gas Futures Chart -