Option Investor
Commentary

Gas Implosion

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The week before expiration of July natural gas futures the price of gas finally crumbled. Support for two months at $7.60 finally broke and gas closed at a six month low just over $7.00. Milder weather in many areas of the country and no hurricanes in sight convinced traders to close positions ahead of next Wednesday's expiration. Gas in storage rose by 89bcf to 2,344bcf and +18% over the five-year average. I thought this was an expiration event complicated by the lack of hurricanes BUT the August contract also fell to $7.20 from last Friday's high of $8.15. This -12% drop was very unexpected and could have been prompted by other equity market forces.

Meanwhile crude futures held the high ground near $70 as the general strike in Nigeria continued. Experts fear the strike will deteriorate into widespread violence and a significant disruption to oil production.

We had new comments from the IEA mentioning expectations for a ramp in global demand to as much as 88 mbpd in Q4. That would be a historic high and it is thought to be more than we can currently produce. If this kind of demand is coming then global producers will need to be ramping production well ahead of this demand to build inventory levels. According to the IEA inventory levels are down to only 23 days of supply. OPEC continues to refuse to boost output until their next scheduled meeting in September. Everyone knows they are hoping for a hurricane in the Gulf of Mexico to crimp U.S. production and push prices to new historic highs. They are in the drivers seat and we are at their mercy.

We heard from Tanker Traffic that OPEC shipments did rise slightly over the last four weeks despite OPEC's claim to the contrary. Obviously the cheating on the current quotas is increasing. OPEC officials rely on outside research to determine actual member production because cheating is so prevalent they can't rely on members to report valid numbers.

Russia completed another nationalism of a previously private energy project. BP had been threatened with the revocation of its permit to operate the Russian Kovykta gas field. BP caved in just like all the other operators before them of multiple Russian projects and ceded control to Gazprom in exchange for $900 million. The project was expected to cost $20 billion and BP had invested $600 million to date. BP will retain a minority interest of something around 25% in the field. Since Russia has been kicking companies out right and left the payment to BP and the minority ownership should be considered a major win for BP. Most expected BP to end up with nothing. Gazprom also announced the companies will be launching a $3 billion global venture. BP had never booked any reserves from this field because of the Russian threat to take control. This suggests there is no downside to BP and only upside. I considered adding BP this weekend but with the announcement after the close on Friday I decided to wait to make sure the market was going to see this favorably.

Refinery utilization plunged to 87.6% for the week and well below the expectations for an uptick to something near 90%. Capacity is 5.7% below normal and were it not for massive imports of gasoline we would be in serious trouble. We are currently importing 1.3 mbpd of gasoline. That is the equivalent output of four average U.S. refineries.

Transocean (RIG) announced a $900 million five-year drilling contract with BP with an option to increase to seven years and $1.2 billion. Transocean will build a drillship for BP's offshore operations. RIG gained +$5 on the news to a new high of $109. RBC Capital markets raised their price target to $142 with the analysts saying they expected more big contracts to follow. Bear Stearns analyst, Robin Shoemaker, said the deal could point to a supply shortage of deepwater rigs and raised their target to $140. RIG has a fleet of 82 offshore drilling rigs. Diamond Offshore (DO) also gained on the news. We are not currently in either RIG or DO having recently exited. These are stocks we will try to reenter on any late summer decline.

Like OPEC we are waiting for the first hurricane to show to break that price resistance at $70. Until then we are just passing time until our planned exit of current positions in August.

Jim Brown


August Crude Futures Chart - Daily

July Gas Futures Chart - Daily

July Gasoline Chart - RBOB Daily

 

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