Last week we saw the October contract drop to $60 on expiration pressures but the November contract rebounded as those traders rolled over into November. That was little help and the November contract gave up its gains and plunged back to $60 on Friday.
As we have been discussing over the last several weeks the surplus of oil, lack of hurricanes and weakening geopolitical concerns provided the perfect opportunity for an end of summer drop. We planned for it and timed our entries to coincide with a drop to $65 on the October contact. We planned to add additional positions if oil dipped to $60. It appears we got both wishes and if current conditions continue we could see oil under $60 next week. That should be just the dip we need to fill on a couple more entries.
As I described in the Option Investor weekend commentary this is the week for mind games. Fund managers not wanting to show losers in their end of quarter portfolios will continue to sell those losers through next Friday. At the same time they will buy or add to positions on those stocks that have proven to be recent winners. This makes them appear smarter than they are and attracts new investors or at least keeps the current investors. Managers will not want to show investors they held on to losing energy positions while oil dropped -$20 and the biggest correction in two years. This puts energy stocks on the sell list next week. Fortunately this is simply a mind game that fund managers play against the uninformed. Once October rolls around they can dump the winners and collect their profits and rotate right back into energy at the lows for the year and wait for the historical winter rally.
This means we have another week of pain ahead of us but the patient should begin to get better once October arrives.
The exception to this scenario could be gas stocks. Natural gas hit a new two-year low on Friday at $4.59 and there is still more pain ahead. Gas in storage hit 3,177 BCF and a record high for this time of year. With maximum proven capacity somewhere in the 3,500-3,600 BCF range and weekly insertions into storage averaging about 90 BCF we are going to hit that max cap very quickly. There is already price competition as pipeline and storage operators take the cheapest gas into remaining storage to maximize their eventual profits. This will get worse over the next couple weeks unless the current cold front is here to stay. The snow storms in the Rockies and plains this weekend will produce a draw on supplies and that could provide a safety valve for prices. I would not bet on it.
In reviewing about 50 gas companies over the last couple weeks almost all of them, especially the major producers, have hedged their remaining 2006 and most of their 2007 production at floor prices from $8 to $12. This means they have little if any risk and still retain some upside if prices return to the prior levels. All it would take to completely reverse the current situation would be a strong countrywide cold front that lasted 2-3 weeks. Once those record gas supplies begin to deplete we would be right back in the race to refill storage before the next cold spell. The US does not have sufficient production and pipeline capacity to supply gas as it is needed during the winter. We have to rely on the 3+ TCF in storage when winter starts as a cushion against strong demand. In 2003 we came within only a couple days of running out of gas and having pressures in the pipelines fall to dangerous levels requiring shutting down the pipelines.
I am not planning on entering any new gas positions until we get into October and/or gas falls under $4. There are so many contracts for gas at much higher prices that $4 should be a threshold level where support should hold. In checking the November contract currently at $5.88 there is strong support at $4.50 and again at $3.75. The December contract is currently $7.40 and has strong support at $6.50 and again at $4.75. The January contract currently at $7.81 also has strong support at $6.50. The February contract is currently $7.93 with strong support at $6.75 and $5.00. The reason for the current October contract being so cheap is simple. There are record amounts of gas in storage and there have been no hurricanes, record late summer heat waves or early cold fronts to use that gas and those contracts expire next week. If you are still long those futures your fate is sealed.
I sent an email last Sunday explaining that the VLO position was posted in error. The trigger point had been changed to $47.50 but I neglected to change my personal order. When my order triggered I logged it and wrote it up. I was going to remove it from the portfolio but with Friday's close at $48.19 that is close enough to $47.50 for me. I changed the description to reflect the prices at Friday's close.
The November contract spike on Thursday turned quite a few of the new positions back into the green but it was short lived. I am not the least bit worried considering our two-year time horizon.
A reader asked this week why I jumped to 2009 LEAPS instead of 2008 for the new positions. Normally we would cycle into and out of the positions once a year. Because of my expectations for oil to return to $60-$65 from its highs near $80 I decided to spring for the extra $3-$4 per option for the extra year of time. I would rather not be jumping out since I feel we may be getting in at the low for this cycle and possibly the low from now on. We never know when the next geopolitical crisis, war, natural disaster, terror attack, etc will appear and possibly alter the future of energy permanently. If Iran tries to produce a nuclear weapon and ends up blowing themselves up instead it could cause some serious changes in the Middle East makeup. If the current cooling of tensions regarding Iran's nuclear ambitions comes to a head after our November elections we could see Bush go hard line once again. Hugo Chavez could go off the deep end and refuse to sell oil to America. With his $1 billion of arms he is buying from Russia and China he could become a threat that would have to be handled on this side of the pond. Our Gulf oil production is very unprotected from attack by anybody with a boat or plane and it is a wonder the terrorists have not figured this out yet. The Alaska pipeline could easily be severed and kept out of operation for years if the terrorists were smart. We are very vulnerable due to our addiction to oil and the world is a crazy place. I did not even get into the Peak Oil scenario that is looming just over the horizon. That could quickly come into play if the production of a major producer was crippled. If we can get good long-term entries at strong support levels we should be very glad to pay the small increase in the premium.
We were only triggered on one new entry this week and that was Anadarko. We may be triggered on LTR on Monday once the Federal judge rules on the certification of class action status in the tobacco lawsuit. Judge Jack Weinstein will issue the ruling at 10:AM on Monday. This could send the stock soaring or plunging depending on the ruling. I considered taking the entry today as of Monday's open but with the potential for a catastrophic ruling I decided against it. Loews is not just a tobacco company. They own 85% of Boardwalk Pipeline Partners (BWP) and 54% of Diamond Offshore (DO) along with the Loews hotel chain and several other companies.
I think it is a testament to the strength of our positions when nearly half either gained, broken even or lost only a few cents for the week. For instance SU, SLB, CEO, UPL and PXP all gained ground or broken even for the week and it was a BAD week. Others lost only slightly, FST -.40, ATPG -0.60, PTR -1.50 ($110 stock), XTO -1.35 and it is a gas stock! Keep the faith until the September energy dump is over.
I did get several requests for "other than energy stocks" to be added to the portfolio. I also received several asking to stay strictly energy. It was about 50:50 and I decided the best direction would be to suggest plays outside the energy sector only if they represented a significant opportunity. Those who are not interested in them can simply pass. I promise to keep the extraneous entries small and only when I believe it is a sure thing. (grin) I am adding a homebuilder this weekend with a long-term LEAP. We have two housing reports next week that could provide a catalyst and interest rates are crashing. This could be the right time.
December Crude Oil Futures Chart - Daily
December Natural Gas Futures Chart - Daily