Option Investor

Crude Breakout Continues

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Despite a complete lack of fundamental support the breakout in crude continues with Friday's close at $72.81 an 11-month high. Crude inventories are still at decade highs and no hurricanes in sight. Even the refinery picture is improving with three coming back online this week after protracted outages.

Conoco's 150,000 bpd refinery in Borger is being restarted after a 6-week outage. Sunoco is restarting their 85,000 bpd refinery in Tulsa after a 4-week outage. Exxon is restarting production from their large Beaumont refinery this weekend. There is no start date yet for a restart of the flooded Kansas refinery but there was no damage and they are just waiting for the surrounding water to settle. Still, gas futures soared to their high for the year with a $2.31 close on Friday.

Nothing has changed on the global outlook to push crude prices higher. The same set of circumstances we saw last week and the week before are still in the news and none got worse. This is simply a run by the bulls and they are crushing shorts by the thousands. $75 appears to be the target price and still no hurricane. I shudder to think what would happen if a category 4 storm appeared around Cuba and headed our way. We could see $80+ dollars a barrel in a heartbeat.

Brent crude is also hitting records but for different reasons. North Sea production has been dropping sharply due to depletion and some major problems at several offshore platforms. They are expecting a 300,000 bpd drop in production for June. Brent was nearing $75 last I looked and it should get worse. This could be one reason WTI prices are soaring as well. If Brent is unavailable the refineries will have to bid for WTI to keep production running.

With all the refineries coming back online you would expect gasoline prices to decline and crude inventories to drop. That may happen but very soon several refineries are going to have to shift production to heating oil to prevent a shortage this winter. Heating oil inventory levels are -42% below the same period in 2006 because all the operating refineries have been concentrating on gasoline.

I fear we are sitting up for a repeat of last year's oil crash. If you remember prices ran up into the first week of August with the current August contract nearing $81. The Sept-06 contract hit $79.45 on July-14th before the crash began. Rising gasoline inventories as the summer driving season began to ease prompted gasoline prices to implode followed immediately by crude. The ensuing crash knocked -$15 off crude prices by summers end.

We are setting up for exactly the same kind of crash. The summer driving season is more than half over with summer family vacations ending by the second week in August. Once it is clear that there is plenty of gasoline to get past Labor day the crash will begin assuming there are no hurricanes headed for the gulf.

It was under reported but finished gasoline production last week was the highest since the EIA started reporting the weekly data in 1982. With all the refineries coming back online we could easily see that record broken over the next couple of weeks. That will take all the bullishness out of gasoline prices and by default oil prices as well.

Saudi Arabia is planning on bringing 500,000 bpd of light crude online before year-end. Odds are good they will cut back on heavy sour crude to capitalize on the higher price of the light crude. This will further depress the WTI prices later this year if those plans are not changed.

We have been preparing to exit many of our energy positions in early August to beat the normal end of summer decline. We may have to move that timetable up by a couple weeks to capture the current highs. It would be nice if we could get one more week and a move to $75 oil but I would be a seller once that level is reached assuming no hurricanes on the horizon.

We could close all our long term energy positions today and claim we had a good year. They say pigs get fat and hogs get slaughtered. I know several of the positions we exited early went on to some monster gains so I hate to just close up shop in expectations of a crash. I am going to keep pushing the stops higher so any material dip will take us out. We have $15-$20 profit in some of those positions so any exit from here would continue to be profitable.

Notes from around the world.

The number of autos globally is expected to rise from the 700 million in 2005 to 1.2 billion by 2030 according to OPEC. The biggest gains will come from developing countries, primarily China.

China, through the China National Petroleum Corp (PTR), won the rights to explore oil sands in Canada's Alberta province. This is a breakthrough according to China.

Conoco CEO James Mulva questioned last week whether supply will be developed to meet the EIA's optimistic demand expectations. He believes demand will be constrained by supply. That is a polite way of saying peak oil will arrive.

Chevron postponed development of its $3.5 billion Tahiti project in the Gulf of Mexico due to metallurgical problems with the mooring shackles in the very deep water. It was supposed to begin production in 2008. This is how production estimates always fail to come true. There are always unexpected problems when stretching the drilling envelope.

Petro Canada (PCZ) will spend C$26.2 billion to build a new oil-sands project in northern Alberta. The Fort Hills project is planning on producing 280,000 bpd of synthetic crude by 2014. Nobody said where they are going to get the natural gas to fire the boilers.

The International Energy Agency's (IEA) chief economist Faith Birol said last week that "If Iraq production does not rise exponentially by 2015 we have a very big problem, even if Saudi Arabia fulfills all its promises. The numbers are very simple, there is no need for an expert." The IEA has been very optimistic projecting oil demand to rise to 125 mbpd by 2030. We currently have trouble producing 85 mbpd. Recently they have been hedging their statements with comments like "$2 trillion must be invested in exploration and production to meet global demand by 2030." Since it is extremely unlikely that amount will ever be invested by OPEC nations the end result is clear. Peak oil will be arriving earlier than the IEA had previously expected. Part of their forecast is for Saudi Arabia to increase production from their current 9 mbpd to 15 mbpd by 2015. Even Saudi with their most optimistic projects and tens of billions in new investment only expect 12 mbpd by that date. This appears to be the IEA's way of blaming their miss on Peak Oil by 25 years on OPEC. Birol's comments imply that Peak Oil could come as soon as 2012 and they always understate the problem. Birol called into question Saudi Arabia's reserve claims and called on Saudi to make public verifiable data to support their claims. The term "when pigs fly" came immediately to mind.

Keep looking for storm clouds in the gulf and raised stop losses on the plays.

Jim Brown

August Crude Futures Chart - Daily

August Gas Futures Chart - Daily

August Gasoline Chart - RBOB Daily

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