Option Investor

Right On Schedule

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The post OPEC meeting, futures expiration dip is over and the rebound has begun. Last week saw crude futures fall to $56.10 on the expiring April contract but only $58.80 on the now current May contract. The rebound was swift to hit $62.65 on Friday amid new tensions about Iran and a revised hurricane forecast for 2007.

Iran captured 15 British naval troops while they were inspecting a private vessel in Iraqi waters. They were taken back to Iranian soil and their boats impounded. Iran said they were captured to protect the "Iraqi oil terminal." That has to be the lamest excuse ever. We are taking British seals off a civilian ship where they were inspecting for contraband cargo in order to protect Iraqi oil terminals. The Iranian leadership must be breathing too many oil fumes.

Eventually they will be forced to return the captives and then the real fun will start. Any future attempts by the Iranians to protect anything in Iraqi or international waters will likely end up creating a new submerged reef with a high metal content. I am sure the military powers on our side in the Gulf are going to be just waiting for another stunt for some serious payback. That is guaranteed to escalate the tensions and the oil prices at the same time.

The Iranian president cancelled a planned trip to New York to make a speech and plead his nuclear case in front of the UN Security Council on Saturday. He claimed it was due to a delay getting a visa from the US but other officials claim it may have been fruitless to claim to be peaceful only one day after attacking troops from another country in Iraqi waters. He would probably have found it difficult as well to argue the case for nuclear trust while the Iranian Supreme Leader Ayatollah Ali Khamenei warned on Wednesday that they would continue their nuclear plans illegally if the UN tries to stop them. It is tough to appear peaceful and law abiding when your not and your press releases precede you.

British storm forecasting group Tropical Storm Risk (TSR) warned this week that the 2007 hurricane season could be 75% stronger than the 1950-2006 averages. For the 6-month season which begins on June 1st they predicted 17 tropical storms of which 9 will strengthen into hurricanes. Four of those are expected to be intense and destructive. They had originally predicted a 60% increase but the rapid dissipation of El Nino in February led them to increase their storm estimates. With crude inventories reduced due to the OPEC production cuts and prices already hovering over $60 it did not take energy analysts long to start talking about $70 crude before the year is out. If we get even one storm in the Gulf that shuts down the rigs the amount of crude in storage will suffer and prices will rise. To add to that shortage the government announced this week they are going to start adding to the strategic petroleum reserve in May at the rate of 129,000 bpd. This will also reduce the available oil.

The SPR currently contains around 689 million bbls of oil and the government is going to add 4 million bbls. They also submitted a request last week to officially double the size of the SPR to 1.5 billion bbls. The government said it would buy crude in the open market beginning in May to add that 4 million bbls. This is the first time in 13 years we have needed to buy commercially. Normally oil producers transfer oil to the SPR instead of royalty payments on the oil they produce. This keeps the government from having to buy it on the open market. After the initial fill ending in July the government is planning on reactivating the royalty oil program to increase the SPR to 727 mb by the end of 2008. Observers will be watching China to see if they are going to add to their SPR reserves as they have already indicated. This sudden interest in adding to global reserves comes at a time when overall global demand is expected to be the highest ever. The EIA said US refiners are expected to boost processing rates to an average of 15.8 mbpd in May. That is a jump of 1.2 mbpd from current levels and would be +282,000 more than last year. The EIA is anticipating record high global oil demand in Q2 of 84.6 mbpd, up +1.3 mbpd from 2006. Q2 typically sees a drop in the demand for oil as winter demand slows and summer demand has yet to increase. The EIA is expected to show the smallest drop in demand since 1985.

On October 5th, 2005, U.S. Energy Secretary Samuel Bodman requested the National Petroleum Council (NPC) to conduct a global study of global oil and natural gas supply. The motivation by the Secretary was an investigation into the timing and response to Peak Oil and the subsequent decline of world oil production. Hundreds of organizations and individuals have contributed to the process. Three weeks ago there were two multi-hour web-cast conference calls where the NPC heard comments from many prominent researchers in this field including Colin Campbell, Matt Simmons and others. A draft report is due out in April and the final report due out by late June. You can track the progress on the NPC website at http://www.mpc.org. There are a couple of interesting power points already posted but nothing referring to the final draft until April. Let's hope it is not just another government cover up in progress.

The IEA raised their global demand estimates for 2007 to 86 mbpd, an upward revision of 273,000 bpd for all of 2007. They predicted China's demand would rise by +2%. Since demand from China rose +9.3% in 2006 the odds are good that 2% target will be soundly beaten. According to China they consumed 6.9 mbpd in 2006.

Iranian production is falling as fields age and equipment wears out. At the same time Iranian consumption of oil products is growing. The EIA is projecting Iran will become an importer of oil rather than an exporter by 2020. Since Iran currently has the second largest reserves this is a major change in production trends and will have a resounding impact if it comes to pass.

Even Greenspan sounded off on the topic of energy recently. He warned that crude oil supplies are precarious and susceptible to disruption. (No kidding?) He explained that new discoveries take a long time to put into production and even small disruptions create large movements in prices. "We are treading on the edge in which any minor catastrophe creates a spike in prices." I wonder if he just learned this or he is having a senior moment where stray facts suddenly return to his consciousness? He also said, "a sharp decrease in supply would have a very major impact on global economic activity." Alan, toss your calendar you are no longer relevant. There is a rocking chair somewhere calling your name. Thanks to Dave R. for the Greenspan article!!

In the truth is stranger than fiction department a bill was introduced in Florida last week to ban oil drilling within 250 miles of the coast. Another bill was introduced that would allow drilling within 45 miles of Florida's coast. Congress approved a bill and Bush signed it last year that provided a safe zone of 125 miles from the coast. Don't they have something else to do in Florida than argue about places to drill?

For next week I would like to think the rebound in oil prices will continue but I suspect there needs to be some profit taking before the next move higher begins. Nat gas prices rebounded back over $7.25 on the continued cold weather in the northeast but their time is rapidly fading. Storage levels are nearing the 5-year average but winter is done with the first day of spring behind us. I expect a drip back below $7 very soon.

Jim Brown

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