Option Investor
Commentary

No Complaints!

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The solid string of gains in the price of oil has done wonders for our portfolio. While not everyone is back into the green we did make significant progress. Unfortunately our OIX hedge against a potential decline in oil prices was severely beaten. Down on one, up on 14, I have no complaints. I checked the volume on the OIX puts and only 5 traded by Wednesday and I was two of them. That means I was nearly alone in that hedge. This time it worked out in your favor!

I outlined the factors pushing oil prices higher in the Option Investor commentary this weekend. Those are Iran, rising gasoline demand and refinery problems. I also outlined the growing danger of increasing inventory levels in crude as we near the mid point in the summer vacation cycle. After July 4th we should see a moderate decline in demand until we near the Labor Day holiday. I believe we will see a sharp correction in oil prices well before that date unless Iran does something stupid or we get a string of hurricanes headed into the gulf.

For this reason I am refraining from adding any further energy plays to the portfolio. We will take any further gains from existing positions and then stop out when the decline begins. We will then reload with 2008 LEAPS on the Aug/Sept dip. I am going to average down on my OIX hedge on any weakness. OIX 626 is strong resistance and the index closed at 618 on Friday.

Oil and gas inventory levels have been postponed until next Friday from their regular Wednesday schedule. I expect a drop in gasoline and refinery utilization due to the oil spill in the Gulf. This should send prices even higher and we will snug up our stops.

Natural gas saw a +66 BCF injection into storage giving us a total of 2,542 BCF in storage. That is 618 BCF or +32.1% above the five-year average and +409 BCF over last years levels. It is so high that storage facilities may put off buying additional gas in hopes of finding cheaper prices at a later date. If storage facilities slow their buying the pressure will build in the pipelines and higher pressure slows injections into the pipeline at the well sites. Some producers faced with falling prices may restrict production in hopes of getting higher prices later in the year. December gas futures are still over $9.50 and producers could hedge into this contract depending on production capacity and prior hedges. This entire scenario is bearish for gas prices and we could see prices well under $6 very soon. The industry is holding their breath hoping for some hot weather to drive up demand. The wet weather in the northeast has slowed demand from that region. Falling gas prices will eventually hurt oil prices since they trade on a BTU equivalency.

I believe gas prices would have already imploded were it not for the fear of another hurricane in the gulf. The damage to gas supplies in 2005 was substantial and gas prices in 2006 are still trading with a fear premium. At present there are no tropical storms on the horizon in the NOAA forecast. For a summer that was slated to produce an abundance of storms the weather in the gulf has been rather tame.

Combine the natural gas glut with the growing inventories of crude oil and it is a clear picture of trouble brewing. We have nine energy positions including 3 coal and we have no gas positions. We will need to manage these positions wisely over the next several weeks.

I am keeping it short this week due to the holiday. Next week should be boring unless oil prices crack or Iran explodes. The Iran problem should escalate on Wednesday if they fail to meet the new deadline with a response. How it will impact oil depends on how many comments Iranian officials make about oil as a weapon. Meanwhile oil prices appear ready to test the old highs. It is amazing how geopolitical conditions can offset short-term fundamentals. Start putting your stops in place so you can sleep peacefully and have a happy 4th!


August Crude Futures - Daily

December Crude Oil Futures Chart - Daily

December Natural Gas Futures Chart - Daily

 

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