Option Investor

Could It Be A Bottom?

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Last week we saw the October contract crash back to $60 before expiration. Fast forward to the now current November contract and it too crashed to $60 before buyers rushed in for the save. OPEC members are moaning the loss of revenue and several are making voluntary production cuts to prevent any further drops in price. Is it a bottom in the making?

I would be real surprised if we traded much below $60 but I would not be surprised if we traded at $60 again. There is simply too much oil with total petroleum stocks rising +9.2 million bbls last week. Gasoline rose by +6.3 mb and the largest weekly gain since Sept-2001. Everybody has to face the fact that once vacations were over consumption of expensive gasoline fell off a cliff. No major news there but you would think the world was coming to an end from the whining in the energy sector. Complicating that drop in consumption was a surge of imports by +660,000 bpd higher than the week before. Black gold, Texas Tea, oceans of it.

Before you race to the exits I need to convince you this is normal. October is always bearish for oil as the summer demand slows, supplies grow and refineries go offline to convert to winter products. The situation will correct itself and OPEC will likely help us whether by open announcement or clandestine cutbacks. The global economy may have tripped over the high prices but it did not crash. China is still surging with oil imports up +18% last month alone. It is just a seasonal cycle made worse by the record prices.

Venezuela announced a -50,000 bpd cut in production and Nigeria announced a cut of -120,000 bpd. This is 3.6% of their total production but it is a start. Saudi has not announced a cut but one analyst said Saudi shipments were still slowing. We already know Saudi had cut production by more than one million bbls a couple weeks ago. For them to cut a few more without an announcement would only make sense. Saudi produces 8.3 mbpd and is by far the largest producer on the planet. They are known as the swing producer because they take up the slack when demand is high and lower production when demand is low. Rumor has it that current production has fallen under 7.0 mbpd.

Algeria announced a new energy law, which gives the state run company Sonatrach a 51% interest in any new venture and enacts a windfall profits tax on foreign producers whenever oil is over $30 per bbl. The biggest companies in Algeria are APC, RDS.a, BP, BHP, ENI and HES.

Equatorial Guinea also passed a new hydrocarbon law mandating ownership rules and a mandatory payment schedule for royalties. Details will be released next week. The largest companies in E.Guinea are XOM, HES and MRO. Just a normal day in the oil patch and another headache for those who have invested billions in development.

The good news for the week is an apparent bottom in natural gas prices. Several producers have said they would shut in supplies if the price falls under $5 and Chesapeake (CHK) has already shut in 100 mmcf per day until prices rebound. With gas in storage as of 9/22 at 3,254 BCF we are still approaching maximum storage limits. There will likely be some further volatility between now and November 1st and the start of heating season but $5 is likely to be the eventual support price. I would be a buyer on any dip under $5 over the next four weeks.

The blue chip markets rallied to new highs last week but energy did not go with them. Many of the major players did rebound but we are far from announcing a new bull market in energy. It was enough to put a bunch of green back on the position table and I am not complaining. None of our watch list entries were hit so we have no new entries.

I am expecting some market weakness next week and I would not be surprised if it was severe. If this comes to pass it may be our final buying opportunity for energy positions ahead of winter. Check the watch list for new targets and new candidates.

November Crude Oil Futures Chart - Daily

December Crude Oil Futures Chart - Daily

December Natural Gas Futures Chart - Daily


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