Option Investor

Short Covering

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I told everyone last week it might be their last chance to buy the dip and sellers finally evaporated on Wednesday. A failure to fall any further and several news events triggered a very strong short covering rally on Thursday and those gains held on Friday. When you consider the June contract expires on Tuesday it is surprising we did not get more profit taking from the dip buyers on Friday.

Gasoline futures continued to rise hitting $2.44 on Friday and were credited with supporting the price of oil. The average price for the week on the futures was $2.36 and Friday's AAA national average at retail was $3.13. The market could be primed for another move higher as we approach month end. Nigerian workers are preparing for a countrywide strike on May 28/29th and there is sure to be violence and attacks on oil facilities. Shell has restarted production from the Bonny field but has not yet lifted the force majeure on deliveries. Nigeria can produce 2.5 mbpd of light crude but 815,000 bpd of that production is currently offline and has been offline for many months.

The challenge to gasoline prices in the US has been a continued slate of refinery problems. At one time last week there were seven U.S. refineries with unplanned outages. As of the weekend only four remained down with the BP Texas City plant likely to be offline for another 11 days. Daily gasoline production is running 750,000 bpd below normal and current inventory levels are -7% below five-year average. AAA expects a +1.7% increase in the number of drivers planning to travel over 50 miles or more during the Memorial Day holiday. The EIA claims gasoline demand had been rising by 2.2% through the first four months of 2007 but when prices topped $3 in some areas in late April that growth slowed to only +1%. The slowdown in demand growth appears to have started in late April. In the four weeks ended April 20, demand averaged 9.34 million barrels a day, up 2.3% for the year, before the rate of growth slowed down to 1.6% the next week and to 1% the following two weeks.

Last week the IEA warned of trouble ahead for global oil supplies if OPEC did not increase production this summer. The IEA said it was concerned by the sharpest draw in 11 years on OECD inventories with supplies dropping -17 million bbls in March. The IEA said that May production had already been cut by another 220,000 bpd in Nigeria and another 60,000 bpd by a platform fire in the Congo. Total declared force majeure on the Congo production. OPEC continues to claim the market is "well supplied" and they have no intention of meeting again to discuss quotas until September 11th. Meanwhile a Platt survey said OPEC shipments were 770,000 bpd above their current targets. This suggests several countries are already cheating on quotas. The IEA says global production will have to increase by nearly 2% in 2007 to 85.7 mbpd to keep ahead of demand. Many believe an increase of this size will be impossible due to depletion at several large fields including the Canatrell field in Mexico, the continued problem in Nigeria and declining production rates in Russia and Venezuela due to financial and political reasons. A recent study by PFC Energy showed political factors were limiting capacity in Mexico, Venezuela, Iran, Iraq, Kuwait and Russia.

Next Tuesday we will get another hurricane update from one source but Professor William Gray from Colorado State University and a 20-year pioneer of seasonal hurricane prediction methods reiterated his own warnings on Friday. Speaking at the Governors Hurricane Conference in Fort Lauderdale with more than 4,000 attendees, Gray stuck to his April prediction. He expects 17 named storms, nine hurricanes, including 5 with winds greater than 110 mph. He said the probability of a category 3 storm or greater hitting the coast is 74% compared to an average of 52% over the last century. His group will update their predictions again on May 31st and August 3rd. We have already had one named storm this year called Andrea. The season begins officially on June 1st.

Iran will begin rationing gasoline on May 22nd. They hope to curb imports, usage and increase fuel efficiency. This is bound to create some serious civilian unrest and will be a challenge to Ahmadinejad's popularity. He has his own website and even has an English version. http://www.president.ir/eng/ President Bush told reporters at a joint conference with Tony Blair on Thursday that the US and Britain would work together to implement new sanctions through the UN if Iran continued to work on their nuclear projects. Shortly after Bush spoke a senior Iranian official told the official new agency Mehr that Iran was installing 3,000 centrifuges at Natanz, which would allow it to process enough material to build one bomb per year. I am not kidding, they actually said that. Since France, Britain and Germany officially reject military action against Iran and Russia and China emphatically oppose such a move it will fall on Washington to take action if Iran refuses to comply with the UN resolutions.

The dumb move of the week award goes to Credit Suisse. With DO at $88 they upgraded the price target from $106 to $107 and kept an outperform rating. $106 to $107 are you kidding?

We had a good week for the portfolio but it is becoming increasingly harder to find new entries. With many energy stocks at their highs and desirable non-energy stocks also overbought it is simply not the right time to continue adding plays. We need to let the ones we have mature rather than continually adding more. I seriously considered adding USU this weekend but could not force myself to take the plunge. It is a uranium company that converts Russian warheads into fuel for nuclear plants. They just received approval for another nuclear facility in Ohio and the stock is moving sharply higher. We already have a uranium play in CCJ so I passed. If you have a favorite stock that you think would make a good play you can email it to me and I will consider it. Having extra eyes on the market never hurts.

Jim Brown

June Crude Futures Chart - Daily

July Crude Futures Chart - Daily

June Gas Futures Chart - Daily

June Gasoline Chart - RBOB Daily


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