Option Investor

Where's the Bull?

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The week before the majority of energy earnings is normally expected to be filled with excitement and expectations of strong profits. Instead energy stocks were sold again and again and again. There was no specific reason just more sellers than buyers.

Oil prices fell from their $78.40 high the previous Friday to trade as low as $71.60 before rebounding to close at $74.40 on Friday. That sentence is somewhat misleading since a contract change from August to September occurred on Friday. Much of the decline from the highs was due to the expiring August contract and a reduction of tensions regarding Iran and the Israel/Lebanon conflict.

The Friday contract change and Israel's planed invasion of Lebanon over the weekend should be fertile ground for a future retest of the highs except for the supply issue. Oil inventory levels continue to be robust and summer driving demand is due to decline as summer draws to a close. We did not see that decline last week as demand rose +1.6% year over year with the 4-week average up +1.9% YOY. It will decline with prices comfortably over $3.00 in most areas.

Valero took 65,000 bpd of gasoline production offline for 20 days in St Charles, LA, for repairs. Conoco lost 360,000 bpd of production at its Wood River refinery after a power outage due to a local storm. Neither loss will impact prices or inventories substantially but will provide support for current gasoline prices.

Oil inventories were unchanged for the week but gasoline supplies rose +1.5mb due mostly to timing of imports. Refinery utilization rose to 92.9% fro 90.5% the prior week due to the ship channel refineries getting back to full production. Utilization will dip again next week due to the outages listed above.

The selling in the energy sector has been way overdone. I expected some selling once profit taking began in crude oil when the highs began to fade. It is simple logic that a new historic high just before a drop off in demand should produce some profit taking. I had hoped that the appearance of a hurricane, Iran going back to the UN Security Council or North Korea receiving sanctions from the UN would have been enough to support prices. Alas, tropical storm Beryl was nowhere close to the oil fields, the UN was strangely silent on Iran and North Korea's response to the sanctions was completely ignored.

I was planning on some further cost reduction strategies once energy earnings were mostly behind us after next week. Nothing ruins a covered call strategy more than a huge spike on an earnings surprise. Now that stock prices have rolled over on profit taking ahead of the earnings events it could make it more difficult to enter a successful covered call. However, oil is still hovering around $75 and odds are good a hurricane will eventually appear. That could push prices back towards $80 and give us one last chance before the August demand slump.

On the bright side several stocks have taken a pounding and any further declines in August could present some really good buying opportunities. I am going to continue to add potential targets to the watch list without entry points. We need to be ready but not trigger happy.

Natural gas has been extremely volatile given the very hot temperatures and a slowdown in injection into storage. The decline in price has made it more attractive for power companies with dual fuel capability to burn gas and that increased consumption is producing spikes back over $6. Unfortunately the cheap gas means coal is no longer king. Coal stocks were hammered last week after BTU warned that Q3 earnings would be below expectations due to pricing patterns for Q3. Cheap gas is prompting the dual use facilities to burn gas not coal. They did raise their guidance for the full year saying some new contracts were signed for more than double the price received per ton in 2005. Coal shipments continue to be constrained by railroad capacity. Peabody said US railroads have announced plans to invest more than $200 million by 2008 to expand Powder River Basin capacity and allow increased deliveries by Peabody. There were numerous positive comments in the Peabody press release. Check the play description for more info.

I know it is tough to watch our positions erode for no apparent reason but this is a long-term portfolio newsletter. I have no problem with anyone trading the recommendations but I am not going to do it in the newsletter. The long-term growth potential for the energy sector is better than any other investment you can make. It is also one of the most volatile investments you can make. Be sure to do your own research on each position you enter and know where you are comfortable adding to those positions or exiting when they go against us. Keep the faith and think long term.

With the rise in oil prices the devastation from May/June had almost been reversed with eight positions back in the profit column. Last week eliminated four of those with a big part of the blame going to BTU. The BTU warning crippled Walter, Arch Coal and cut our BTU LEAPS in half.

We had been planning on exiting many positions on an expected decline in August and I had raised some stops over the last couple weeks. Last weeks selling took us out of several and we are close on some others. Some of that broad weakness could also have been option expiration activity further stimulated by the expiring August crude contract. I am going to continue slimming the portfolio in anticipation of a buying opportunity in late August. We will reenter some of the exited positions using 2008 LEAPS.

September Crude Futures - Daily

December Crude Oil Futures Chart - Daily

December Natural Gas Futures Chart - Daily


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