Option Investor

Back On Track

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After a brief rebound from the post Ernesto lows the price of oil closed at a new five month low for the October contract of $69.25. Support at $70 is losing its grip and even the 200-day average at $69.75 did not help. The next support level is $65 and without a new storm in the Gulf or a stupid move by Iran it seems we have a very strong chance of hitting that level.

That would enable us to fill on most of our watch list targets. Rising crude inventories despite the Alaska pipeline problem and Nigeria production problems are causing some to wonder if we are approaching an oil glut. Gasoline inventories rose more than expected and this weekend marks the end of driving season. The gasoline shortages many feared by the switch from MTBE to ethanol never really appeared. Refining margins have fallen to 20 cents a gallon and right in line with seasonal norms. They should remain low for the remainder of the year. Gasoline inventories are 5.6 million bbls over the 5-year average. That will not give any support to oil prices over the next few weeks. Heating oil supplies are at levels not seen since 1999 and a near glut.

Oil will not see any help from natural gas prices either. Last week saw an injection of +48bcf into storage bringing total gas in storage to 2.905 tcf. This is 12.4% over the five year average but that percentage has been falling weekly as the heat wave took gas out of the pipeline. With cooler weather ahead we should see injections of 65bcf or better each week in September and October. That will bring gas in storage on November 1st and the start of winter to right at 3.5 tcf and the limits of current storage capacity. This should cause gas prices to ease over the next 60 days as we close in on that 3.5 tcf number. Because gas and oil trade on a relative btu basis it should continue to weaken oil price support.

Energy prices suffered major losses in August with Crude losing -7%, heating oil -5.5%, gasoline -24% and natural gas -28%. Those are some very bearish numbers despite us heading into the peak of hurricane season. Now that we are only two weeks away from the peak of the season around Sept 10-15th AND the driving/cooling season is over we could see some dramatic drops in energy prices after Sept-15th assuming no hurricanes. I seriously doubt we will escape the entire season without at least one major threat and that prospect will provide some level of underlying support into early October.

Transocean Offshore (RIG), announced on Thursday it had received a 5-year contract worth $862 million to build a drillship for Chevron. The ship would be modeled on RIG's enterprise class drillship design which allows for parallel drilling operations designed to save time in deepwater well construction. RIG jumped +4.33 on the news. RIG also announced that a federal jury had awarded it $3.6 million in damages from GlobalSantaFe (GSF) for using patented RIG technology on two of its offshore rigs. The jump in RIG also powered the Oil Service Index (OSX) back above support and lifted other drillers in the sector.

The Transportation Index is benefiting from the drop in oil prices and I considered adding CSX back into the portfolio. CSX has found support at $30 and could be ready to rebound. However, falling gasoline/diesel prices also make it less attractive to ship by rail. I weighed the options and decided to take the plunge with a $5 2009 LEAP. With that kind of risk it is hard to say no.

I sent out an update on Wednesday night lowering some targets on several watch list entries. My initial expectations for an oil price decline may have been too reserved now that Ernesto missed the Gulf. I am targeting $65 oil with those new watch list levels.

October Crude Oil Futures Chart - Daily

December Crude Oil Futures Chart - Daily

December Natural Gas Futures Chart - Daily

September Unleaded Gasoline Chart


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