Option Investor


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There is no sanity left in the energy market. Oil surged on the suddenly appearing Hurricane Humberto and hit $80 for three consecutive days. It appears to have found some serious resistance at that level and there was no shortage of sellers whenever the contract peaked over that threshold. They did not chase it lower, having learned a series of painful lessons over the last couple weeks. Every dip was bought and bought aggressively.

I think the bullish momentum players have run out of rope. Trading terminates on the October contract on Wednesday. Those hoping to hold on to their positions in hopes of tropical storm Ingrid turning west or another massive drop in crude inventories are rapidly reaching the point where they either take profits to avoid the rush or get caught in a serious downdraft in the closing hours of the contract. At some point reason should resurface and logical decisions appear. However, logic and reason make only brief appearances in the commodities markets a few days per month.

There is no economic or fundamental support for oil prices at this level. It is strictly the only game in town as we await the Fed decision and earnings on the brokers and every available player has crowded up to the table.

Last Tuesday OPEC teased the markets with word games switching to "production" instead of "quotas" and ignoring the prior targets. We know that the prior quota was 25.8 mbpd for the OPEC 10 countries. The remaining two OPEC members, Iraq and Angola, have no quotas. The OPEC-10 were actually producing 26.7 mbpd or +900,000 barrels over their quotas. The total production for all 12 OPEC members was 30.3 mbpd.

After the meeting where they decided to officially add +500,000 bpd to the market they announced the OPEC-10 were going to produce 27.2 mbpd for an increase of 500K. Reporter after reporter asked any official, delegate or oil minister that would step in front of a microphone "what happened to the quota." They squirmed and fidgeted and mumbled in broken English "we are going to add 500 kbpd to production." Reporters trying to be cute would say that means your quota is now 26.3 mbpd, knowing full well what the answer would be. Invariably they would answer, "We are increasing our production by 500 kbpd to 27.2 mbpd. Basically they were trying to ignore the 900,000 bpd of quota cheating and convince the market that they were only adding a minor amount of oil to the total. In effect they are right but saying we are ONLY adding 500 kpbd to our output seems like a lot less oil than saying we are raising our quota by +1.4 mbpd. They were hoping the impact on prices would be minimal with a +500K gain compared to having the +1.4 mbpd number repeated a million times in the news cycle. Evidently those traders who can't add took their comments at face value and feared a shortage was just around the corner. Why that apparent shortage was only in the October contract expiring in just days is unknown to me. The high in the November contract last week was only $79 with the high $78s getting the most volume.

Since oil inventories are just below 10-year highs I don't see the problem. OPEC said the new production target would become effective on November 1st but everyone with a brain realizes they became effective the minute the camera lights were turned off and the microphones unplugged. When you consider load and transit time it does take 30 days to get new production from the Middle East to the U.S. but we are only talking 500K per day or half a tanker and all of that oil is not coming to us. This is all a shell game with an extra helping of smoke and mirrors to cloud the issue. I am a Peak Oil believer but this is not Peak Oil. It is simply a cleverly played hand by OPEC and they are being well rewarded for their skillful game.

We were stopped out on our XLE put on Thursday and while I seriously wanted to email everyone again and tell them to hold the position I could not in good conscience make that call. I put stops on plays because the market is not sane and logical. It has been a known fact for decades that the market can remain insane far longer than we can remain liquid. We must honor those stops under the assumption that there is something we don't know that is making the position move against us. Capital preservation should be our number one directive with profitable plays secondary. Now that I have said that I will also tell you I am putting the XLE play back in the wish list but with different parameters. Eventually this market is going to crack and we want to be there when it does.

Unfortunately the last two weeks of gains on most energy stocks appear to have taken them way out of range of our entry targets. At this point I don't know if they will come back but I definitely know we should not chase them. Every sector cycles several times a year and energy is no exception. We will just have to wait for it to cycle and then manage our entries during the cycle. I still believe oil will return to $70 or even lower this fall but that belief and $4 will not even get you a decent combo meal at McDonalds.

Our non-energy plays of BSC and CFC finally found a bottom this week, or at least I hope it is a bottom. Countrywide arranged another $12 billion in financing and business volumes for closings in August were much stronger than anyone expected. I think they are now out of the woods and anyone holding off on an entry should probably make it now. Bear Stearns rebounded +$12 off its lows for the week on news a major investor had taken nearly a $1 billion position in BSC to become the largest shareholder. This expression of confidence helped lift them out of their downward spiral. Earnings for BSC are Thursday.

Good luck!

October Crude Futures Chart - Daily

November Crude Futures Chart - Daily

October Natural Gas Futures Chart - Daily

October Gasoline Futures Chart - RBOB Daily


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