Option Investor
Commentary

Grinding Through October

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Energy prices are grinding their way through October as we traverse that period where there is no gasoline demand and no demand for gas. Power plants are offline for refueling and maintenance. Refineries are offline for maintenance and the switch over to winter products. Supplies of all crude products are building for the demand to come as weather turns cold and the holiday shopping spree puts more cars on the road and more gas in the tank. It is October in the energy markets and we just have to live through it.

This year has produced more volatility than normal with prices August reaching $78.40 and addicting OPEC to the higher dollars better than uncut heroin. The sudden fall from those lofty heights and dollars by the ton has produced greenback withdrawal among OPEC suppliers. They are in such a disarray that they can't even agree among themselves on how to structure a production cut. It is bad enough that their $28-$30 band for oil just a couple years ago has disappeared from view and now they are going through withdrawal at $60.

According to the latest news OPEC should announce a one million bbl per day cut on Monday and their intention to support $55 for the OPEC basket of 12 grades of crude. The US contract for light sweet crude typically trades for about $5 more making support $60 and right where oil closed on Friday. I would get used to seeing that number over the next three weeks as traders try to test OPEC's resolve and test $55 with volatility sprints back to $65. It should be an exciting time in the pits and I am glad I don't have to trade there.

The main problem is OPEC's credibility. These countries depend so much on the income from oil that every dollar in decline hurts them. Those that can have been pumping every possible barrel in an effort to capture as much cash as possible while the price was high and falling. Contrary to conventional reasoning they pumped at full production as the price imploded in an effort to capture every last buck while that out of control pumping actually hastened the decline in prices. Now this same band of brothers with zero trust for each other are going to be saddled with a lower quota and expected to honor it. There is little hope this will work and that is why OPEC resolve will be tested. Until supply actually tightens the price of oil will be very volatile.

Natural gas storage is at near peak capacity around 3.4 tcf with current supplies at 3.32 tcf. Gas prices have risen because Chesapeake and Questar have taken 170 million cubic feet per day offline until November. There is also a six-year high in nuclear plants offline for refueling for the next two weeks. This requires more gas to make up the shortfall in electricity generation. Despite these events we still expect gas storage to set new record highs next week and for the next three weeks without an early blizzard to produce demand.

The bottom line is that nothing has changed in the energy sector over the last week other than a new low for oil at $57.70 on Wednesday. Energy stocks have been up and down without a trend and will remain so until late October or early November.

The Peak Oil scenario has not changed and despite what you hear on TV the current glut is only temporary and will go away. I printed some charts based on the IEA numbers in this weekends Option Investor commentary. The charts illustrate that despite the current glut and the spike in global production brought on by record oil prices we are still producing below levels seen in early 2005. The charts were put together to illustrate that the last 18 months have seen rather flat production that could be the beginning of a peak plateau.

In the context of Peak Oil a peak plateau means the point where oil production and oil consumption meet raising prices to record levels. Those record prices reduce demand to slightly below maximum production where that level is maintained in balance for some time until production declines again force prices higher. In simple English $3.50 gasoline slows demand at the point where the peak becomes a plateau rather than a spike. Demand and production are level and kept in balance by higher prices. This theory has been discussed for years as the first signs of the end and the charts in this weekend's commentary could be the first signs. The peak plateau would be negated if actual production rose over the highs seen in early 2005 but with a -8% depletion rate on existing fields that possibility is very low. It will however take a couple years to prove the theory. Peak Oil is not something we can say when it happens, "this is the peak." Peak Oil will not be known until sometime after it happens. When we can look back at the production charts and see solid evidence of a permanent decline that will be when experts can say, "that was the permanent peak in global oil production." By that time it will be too late to matter and oil prices will be heading for the stratosphere.

The volatility helped us get into three more positions this week and that is about all we can carry. We came within a few cents of several others but the rebound in gas prices may have taken them out of range. All in all it was a volatile week and that volatility is sure to continue.

Earnings for energy stocks are not until the last week in October. We could see that volatility increase as we near that period. I have included all the earnings dates currently available. Make sure you have put insurance ahead of those dates if the first few reporters show less than expected results. Traders may not want to own energy over the announcements until after the first couple of reports. Once they have a feel for the sector we could get a trend.

An acquaintance stopped by the house this week and finding out that I studied oil asked my opinion on an oil company she and her friends had invested their retirement in to the tune of $2.5 million. I had never heard of it and could not find any reference to it on the Internet. You know where this is going. I found out that she had responded to a solicitation by an "investment company" and after meeting with the principals of this thriving oil company she joined the group and wrote the check. The principal officer of this "private" oil company was also the webmaster and chief pilot. This investment company also had the group invest in a hotel in Cancun that was subsequently demolished by the hurricanes or so the story goes. I seriously doubt she will ever see her money again. I believe there are tens of thousands of potential retirees around the country who are in this same predicament only the names and events are slightly different. I strongly suggest if you know of people like this you counsel them to reconsider these private investments. Sure there are some good ones but they are few and far between and best left to those who can afford to lose their entire investment. You don't have to give these people investment advice other than avoid somebody making decisions for them. If they only buy the XLE or an excellent mutual fund like the Vangard Energy (VGENX) or Fidelity Select Energy (FSENX) they will be a lot better off and sleep much better at night. For many of these individuals there will be no retirement and they have no clue the only one making any money is the advisor.


November Crude Oil Futures Chart - Daily

December Natural Gas Futures Chart - Daily

 

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