Option Investor

What A Week!

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Oil prices spiked to $77.40 after BP announced it was shutting down 400,000 barrel per day production of the Prudhoe Bay field. The shutdown was not just temporarily but for as long as six months. Since that is high demand light sweet crude the price of oil shot higher with talk of $80-$85 just around the corner.

Before the week was out oil prices returned to their pre announcement level on a variety of news releases and odds are very good they are going lower. As of Friday night the UN had passed a resolution that could end the conflict in Lebanon and both countries are expected to sign it. This relieves the geopolitical concerns that Iran and Syria might become involved in the conflict.

BP announced late Friday that they were going to keep production from the west side of the field open and that would allow 200,000 bpd to continue flowing. BP had already purchased 4.5 mb of replacement oil from the Middle East to supply refineries on the west coast. This was in addition to the 70 million bbls already stored at the end of the pipeline ready to be transported to Washington and California refineries. Mexico and OPEC were quick to offer to supply additional oil to resolve any shortfall from the BP problem. Since Mexican production is declining very fast and they barely have enough to supply current contracts it is doubtful the offer was anything more than lip service. OPEC has no additional capacity of light crude so that was also a hollow offer.

Good news appeared to be breaking out all over with Nigeria reporting that production had been restored in one pipeline and Shell would resume pumping 173,000 bpd of light crude through that line. That brings the level of crude offline in Nigeria back down to only 620,000 bpd. That is 24% of the countries total production.

The drop in oil prices on Thursday was not related to the foiled terror plot as reported on TV. It was due to a dumping of gasoline contracts after Goldman Sachs announced new weightings for its GSCI futures index for Sept and Oct. They removed a substantial amount of gasoline prompting dumping in the gasoline market. The numbers highlighted in blue in the table below represent the changes in gasoline components. Obviously it was a significant change from the August weighting.

GSCI Commodity Index Weighting Change Table

There are no hurricanes on the horizon, gasoline demand should slow significantly over the next two weeks and gasoline inventories are +300,000 bbls over the five-year average. No challenge there. Oil inventories are also high despite the expected six-month drop of 200,000 bbls from the Alaskan slope. Current inventories of 332.6mb are 10.1% above the 5-year average heading into the demand slump. Israel and Lebanon should end the fighting soon and warm weather is nearly over. It sounds like the perfect storm for a drop in oil prices.

I have been saying oil prices would decline in late August for several weeks and yet new challenges continued to appear to support prices. I believe we are about to see that decline unless a string of hurricanes suddenly appears on the horizon. Using those assumptions I am adding some puts and closing some positions to clear the deck. We want to reload the boat on the dip with new positions and longer LEAPS.

Notice in the charts below that the spread between September and December futures has narrowed significantly. The abundance of oil is cooling expectations for winter shortages.

I am going to an energy conference all next week and should have some interesting news when I return. 78 energy companies will tell their story and their outlook for the future. Petrie Parkman & Co. will update everyone on their overall outlook for the industry and project supply and demand for the rest of the decade. It should be very informative. I will take good notes!

September Crude Futures - Daily

December Crude Oil Futures Chart - Daily

December Natural Gas Futures Chart - Daily

September Unleaded Gasoline Chart


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