Option Investor
Commentary

Rocky Week for Oil Prices

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After reading that headline above you are probably thinking, "what else is new?" News reports of production problems due to weather challenges in Alaska and various outages in the Middle East offset news of a sharp spike in oil inventories. On Wednesday the inventory report showed a whopping +5 million bbl build in supplies while refined product inventories slipped lower. The sharp spike in oil prices on Tuesday saw prices climb to $60.40 intraday but the inventory report on Wednesday saw an equally dramatic drop back to $58.35 ahead of the long holiday weekend. Refinery utilization fell to 87.1% as more refiners shut down production for maintenance ahead of the strong winter demand.

It appears to be a conflicting picture of weak demand but in reality the picture is improving. For instance the EIA reported distillate stocks have fallen to 133.8 mb last week from a high of 151 mb back on the Sept-29th report. Gasoline stocks have fallen from 215.1 mb in the same period to 201.7 mb last week. Crude has only risen because refineries are cutting production for maintenance. Utilization has fallen to 87.1% from 93.6% in September. Once the maintenance schedule ends and that utilization increases again that crude stockpile will diminish rapidly. We are also entering the heavy use period for winter, which kicked off last week. 34 million Americans were expected to travel more than 50 miles for Thanksgiving. When they get back home from the holiday trip the family shopping spree begins with increased gasoline usage from extra auto use. We are also moving into the winter heating season with colder weather settling in over the entire country. The usage of home heating oil, gas for heating and electricity generated by gas and coal will increase. We should see further declines in distillates and gasoline inventories over the next couple of weeks as marketers replenish supplies drawn down over the holiday week. According to the EIA current U.S. gasoline inventories only represent a 21.9 day supply. That shows how quickly the picture could change in the event of a major disruption in oil supplies.

I am encouraged by the price of oil holding in the $60 range over the fall demand slump. We have had numerous news events that were bearish for prices but we have seen every dip under $60 bought and support is holding. Stock prices for energy companies have largely been stable with many remaining in a upward trend despite the volatility in energy prices. I continue to believe that we will see another move higher once the winter demand/price cycle gains some traction. The falling dollar is also providing support for oil prices with billions of dollar denominated oil traded each day. Lower dollar value means a higher price for oil.

Weather in Alaska prevented tankers from loading at the end of the Trans Alaska Pipeline. Storage tanks were nearing capacity and operators reduced the flow of the pipeline by 30% from Prudhoe Bay to avoid having the oil in the pipe come to a halt and potentially causing restart problems. The weather is not expected to clear until Tuesday.

Italian Oil company Eni declared force majeure on exports from the Okono terminal in Nigeria after it was attacked. Supply disruptions for the week caused the Qatari Oil Minister to dumb down comments he made last week about the need for another production cut when OPEC meets again in December. He now says it is too early to speculate on further cuts.

Bloomberg surveyed 35 analysts, traders and brokers and 17 said oil prices are likely to rise next week due to expectations for increased heating oil use this winter. Last winter was the warmest on record in decades and that scenario is not expected to be repeated. 10 respondents expected prices to remain flat and only 8 were looking for a decline.

I just returned to Denver from a three week 4000+ mile road trip to the southern US. I paid as little as $1.98 in the Beaumont area of Texas, $2.09 in New Orleans and as much as $2.33 on I70 in eastern Kansas. Clearly being close to the refiners around the Gulf is a plus for cheap prices but elsewhere we seem to have settled in the $2.10 range and about what I averaged paying on my trip. It should be uphill from here. Prices will rise as the current excess in inventory is reduced and traders start looking forward to the high demand driving season for 2007. According to the EIA the average retail price of regular gasoline rose to 223.9 cents per gallon in the last reporting week. This was +3.8 cents higher than the same period in 2005 despite the hurricane spikes we were seeing in 2005. Retail heating oil fell slightly to 237.4 cents, down -5.7 cents from 2005. Everyone may feel that $60 oil is cheap compared to the $78.40 high for the year but it is still well above any sustained prices in our history. This is simply another plateau that we will eventually look back on wistfully as we talk about the good old days to our grandkids.

With earnings over for Q3 the news in the energy sector was pretty sparse. PetroChina was the highlight of the week with a +$8 gain after Citigroup initiated coverage with a "buy" and a price target of $139. Friday's high of $124.28 was an all time high. Our patience was finally rewarded. For the rest of the positions the updates are going to be pretty thin. Without any news and little movement in prices there is simply nothing to update.

This week should be interesting with no additional news expected all eyes will be on the inventory reports for signs of increased demand in heating oil and gasoline and a draw down in crude. We are nearing the 30-day mark for the OPEC cut and about the time that the impact should start being felt. The combination of increased demand and the slowdown in supplies should support prices. The main risk to our positions next week will be the broader market. The Dow finally appears to be weakening but the Nasdaq, S&P and Russell are holding the high ground. How long they can continue to advance or even hold at this level with the Dow slipping is anybody's guess. By all measurements the markets are very overbought and due for a correction. At the same time money flows into the markets are increasing. Bullish sentiment among newsletter writers is a near record highs for the last decade. From a contrarian viewpoint this is a very bearish sign. The VIX spent most of the week under 10.0 and a level of complacency not seen since the early 90s. When a market correction does appear, whether by years end or early 2007 it will drastically impact our positions as profits are taken. For this reason it may be time to begin upgrading our insurance puts. Most existing puts are well out of the money and worthless as correction protection. I will begin suggesting some new positions this week. Of course a major spike up in oil could offset a broad market decline but it is better to be safe than sorry. I raised the entry points on some of the insurance puts and changed some strikes.


January Crude Oil - Daily

December Gas Futures Chart - 90 Min

 

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