Option Investor

Futures Expiration, Again

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We saw volatility return once again as the May futures expire and the June contract becomes the current month. Friday's close on the May contract rose to $63.51 from Thursday's low of $61.34 while the June contract sank over the entire week to close at $64.07 and equalize the prices for the contract roll over. The June contract traded as high as $68.20 in early April and $66.80 just last Friday. The futures expiration was bound to pull the prices closer to parity and we are fortunate the June contract held at $64. We now have four weeks before the process is repeated on May 22nd with the July contract.

Natural gas prices finally collapsed despite a larger than expected -46bcf draw from supplies as the last winter storm wore itself out in the US northeast. Prices on the June contract fell from just over $8 to $7.51 at Friday's close. I still expect to see lower prices until hurricanes begin to form.

This is a major week for energy earnings with four of the major integrated oil heading the list of announcements. With oil prices averaging about $5 below last year's levels during Q1 the odds are good we will see some disappointments. However, because of the difference in crude prices the expectations are not high and we could actually see some surprises. I am not recommending exiting any positions ahead of earnings as we would in short term plays. We will hang on an use any post earnings dips to add to positions ahead of summer hurricane/driving season.

Partial Earnings Schedule

The situation in Venezuela is getting worse. The foreign companies producing in the Orinoco Belt have until May 1st to give 60% of control to state owned Petroleos de Venezuela SA or leave the country. Negotiations are not going well. Exxon has threatened to leave the country and abandon their facilities. Other companies have been very tight lipped about the change and are saying nothing to avoid having their comments used against them later. Last week Chavez said Venezuelan armed forces would occupy the oil projects on May 1st to insure compliance with his decree. The next day he said the oil companies could sue Venezuela if they did not like the situation. This suggests the talks are not going well and the foreign companies are not happy about turning over their billions in investments to Chavez and being forced to operate under Venezuelan control. The Orinoco heavy oil projects produce about 600,000 bpd and it is so technically difficult that most observers doubt PdVSA would be able to maintain current production levels. The US was importing 1.5 mbpd last summer but falling production and Chavez efforts to sell oil to others beside the US have seen that number shrink to something around 1.0 mbpd today. If the Orinoco transfer go badly that number could drop significantly lower. Since the US is already seeing a large drop in imports from Mexico due to the Canatrell field decline this would mean additional imports would be needed from the OPEC overseas. We are already seeing shortages of gasoline imports and a shortage of crude on our side of the pond would create even more problems. A tanker can do a round trip from Venezuela in 10 days but that same tanker takes 40 days to make a delivery from Saudi Arabia.

Chevron has already warned that production in Q1 would be lower because Venezuela took over larger stakes in two fields.

Nigerian elections took place last week and over 50 people were killed in violence around the country. Nigeria exports 1.1 mbpd of light crude to the US and that has been in danger from various militant and rebel factions. It was hoped that the elections would resolve some of the problems but it appears the situation has gotten worse. Last week a coalition of militant groups gave the government 72 hours to withdraw all military personnel from the Niger Delta or they would declare a full blown war. All foreigners were also told to leave the Delta. It was reported in the Nigerian newspapers that multinational oil companies have started pulling out and many projects are on hold because foreign workers are refusing travel to vulnerable job sites.

China reported that its GDP grew at an 11.1% rate in the first quarter and oil imports rose +6.8% to 3.23 mbpd and may accelerate in the coming months as strategic petroleum reserves are filled.

Uranium prices spiked 19% to $113 per pound at a US auction last week. That same pound of uranium sold for $7.10 per pound in Dec-2000. Analysts expect prices to exceed $140 by next year.

In a departure from normal positions on global oil production the IEA said last week that "demand growth has exceeded the capacities put on the market, which are currently barely balanced." "Even if we were happy with the increasing investments in Middle East countries of OPEC, we think the rate of investment and capacity growth is not enough to meet future oil demand." Somebody finally woke up at the IEA! Preliminary figures for March show inventories on track for a draw down of 1 mbpd and the biggest Q1 decline since 1996. The IEA is increasing pressure on OPEC to release more production rather than let supplies dwindle and prices rise. Good luck!

Gasoline inventories continue to fall with a drop of -2.7 million bbls last week. Refinery activity is increasing as maintenance is completed but with spring weather the demand for gasoline is also increasing. It is going to be a race to the Memorial Day kickoff of driving season.

The rebound in builders triggered our watch list entry into Toll Brothers but also set us back on the Beazer Homes LEAP Put. Evidently retail traders don't realize that the charges against BZH could eventually put them out of business. BZH reports earnings next week and that will require an update on all the lawsuits and criminal investigations. That should separate them from the crowd.

Ultra (UPL), currently on the watch list, reported on Friday a +42% increase in quarterly production to 28.5 bcfe. Production in Wyoming jumped +50%. UPL has a 27-year backlog of drilling inventory. Earnings are scheduled for May 2nd.

Jim Brown

June Crude Futures Chart - Daily

May Gas Futures Chart - Daily

May Gasoline Chart - Daily


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