Option Investor

$58 and Holding

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Halfway though October and support at $58 is still holding. I would say it was a very weak hold but no complaints from my side. Energy stocks are rising in anticipation of normal winter demand and possible OPEC production cuts. The price of oil may be firming but many stocks are taking off. On Friday the major winners were MRO +2.84, SU +2.68, NXY +1.85, DO +1.63 and TSO +1.63. For some this was on top of strong gains earlier in the week and in a week when oil prices fell -$1.12. No complaints here!

The only complaint I have is that I am going to be forced to take half the entries off the watch list because they have risen so far over the last week that they are now out of range. We missed ATI by $2 at $58 two weeks ago and it is now $74 and I am not going to chase it. We already have a nice portfolio and earnings are just ahead. We will be fine as long as nobody stinks up the sector. Quite a few of our positions turned green again and by mid November we should be well into the money baring some OPEC meltdown.

The latest news on OPEC is that they have reached a consensus to cut one million bbls per day but the start date has been dropped back to Dec-1st instead of nov-1st. Qatar has offered a meeting spot for late October for all the OPEC heads to get together and solidify the move. There is some discussion about skipping the meeting due to Ramadan. I believe they are just trying to talk the price of oil higher as they wait for the normal winter demand to appear. They can continue to collect $58 per bbl while they posture to the press.

There were several outages this week with 280,000 bpd going offline in Norway for as much as two weeks. 200,000 bpd went offline in Canada due to a problem with an Imperial Oil pipeline. Alaska is still having problems due to weather and pipeline flows are hit and miss. These outages are all temporary but impact the overall inventory levels quicker than an OPEC cut.

Gas storage is creeping even closer to maximum stated capacity of 3,604 bcf with another +62 bcf injection last week. Storage levels now stand at 3,389 bcf. The western producing region actually went over capacity by +9 bcf last week indicating that they are not going to be accepting any more large volumes of gas.

I mentioned last week that Encana and Conoco announced they were going to spend $26 billion in a joint venture to extract more bitumen from Alberta oil sands. There are great hopes for Canada to grow its production of synthetic crude from 1-mbpd to 4-mbpd by 2015. Unfortunately reality is getting in the way. It takes .7 boe of natural gas for every bbl of oil produced. Water is also a problem as it takes 2 bbls of water for every bbls of oil. The problem is falling gas supplies in Canada. The oil sands projects are using so much gas they can't fulfill their export requirements to the US under NAFTA. Gas exports are declining and there is no additional gas to raise future production rates of synthetic crude. They are building several LNG terminals to import gas but if the current trends continue they will end up shipping some of that gas to the US. It is a complex problem and very few analysts are seeing the entire picture.

The oil shale deposits in Colorado and Wyoming are popping up in the news almost daily. The claimed 3 trillion bbls of oil locked into that shale makes for a good headline but little else. I get emails each week from readers who have been spammed with some investment newsletter promising untold riches from the oil shale projects ahead. Bull! One supposed option proposed by Shell is to heat the ground with electricity to the temperature of 700 degrees thereby melting the oil and causing it to flow to a nearby well. This is total crap! They claim to get the rock to that temperature would take continuous heating by extremely large amounts of electricity for 2-3 years. Shell would get a tax credit for building a string of power plants over tens of thousands of square miles only to send that electricity hundreds of feet into the earth. How much power would it take to heat a square acre of rock to 700 degrees? An enormous amount! What are they going to use to generate all that electricity? Not gas, there is already a shortage of that even though you can't tell by the current surplus in storage. Not coal although there are plenty of coal supplies in Wyoming. Building a string of power plants throughout Colorado and Wyoming that would burn coal and conform to the current and future environmental rules would cost untold tens of billions of dollars. Certainly not nuclear because uranium is also in short supply and plants take a minimum of ten years to permit and build and only if you can find a community that wants them in their backyard. All these options require huge amounts of water and since I live in Colorado I can assure you there is no water to spare. The rights to any excess water were sold off decades ago to Kansas and California and I guarantee you they are not going to give them back. My water bill in Colorado is nearly as expensive as my electric bill. Yes, there is oil in oil shale but it will stay there for the rest of my life and probably the rest of yours. Eventually somebody will discover a way to extract it but contrary to the newsletter hype you may have received that method has not yet been invented.

Until that oil shale extraction miracle arrives we need to stay the course and continue putting our faith and investments into long-term conventional reserves being developed by quality, brand name, companies. Investing in companies nobody ever heard of should best be left to venture capitalists with money to burn. Personally I need every dollar I have and would rather not see any go up in the smoke of wishful thinking.

A research note from Goldman Sachs should provide plenty of comfort. You have heard of Goldman Sachs? Goldman Sachs energy analyst Arjun Murti, in a note to clients, said that a "perfect storm" of seasonal and technical factors was to blame for much of the recent drop in energy stocks. Murti sees a rebound energy shares during the fourth quarter. "Fundamentally, we believe global oil demand will exceed non-OPEC supply in 2007, driving our bullish crude oil view, and that natural gas inventories can return to the middle of the range (with normal winter weather) driving a recovery in U.S. natural gas pricing."
Hold that thought!

November Crude Oil Futures Chart - Daily

December Natural Gas Futures Chart - Daily


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