Option Investor
Commentary

Almost But Not Yet

HAVING TROUBLE PRINTING?
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I feel like an expectant father with repeated attacks false labor. Every drop has me rushing to the hospital expecting that oil correction baby only to be turned away in admittance when the false labor disappears. Fortunately, just like having a wife with false labor pains we know that eventually that baby is going to come. I continue to firmly believe that a correction in oil prices will come before winter.

In 9 of the last 10 years there has been a 10% correction in oil prices between Labor Day and Thanksgiving. That does not guarantee one this year but all the factors are in place for it to happen. The storm front has gone quiet. There is nothing in the forecast for at least the next week. Crude inventories are rising along with refinery utilization. There was a small drop in distillates and gasoline inventories were flat. There was nothing in the inventory report to support oil prices. Gasoline demand fell 115,000 bpd from the prior week and right inline with expected reduced demand for this time of year. Note in the chart below that it is moving under the demand for 2005-2006. There are currently 193 days of supply in inventory according to the EIA.

You may have noticed the integrated oils and refiners have not been following oil higher. There have been several profit warnings from the various majors and analysts are downgrading refiners like Tesoro due to shrinking crack spreads. One analyst said refiners could miss earnings by as much as 60%. Can you imagine this scenario? Oil prices are at record highs and have been for over a month and oil companies are warning on earnings? I know it sounds strange but it all comes back to higher costs getting it out of the ground, higher royalties to the country of origin, breakdowns at ancient refineries and the lack of new discoveries. Oil prices will move higher and so will oil stocks after this earnings cycle. This warning cycle is helping prepare our watch list targets for entries.

On Friday Nabors (NBR) the worlds largest land based driller warned that earnings will miss street expectations because of weak natural gas drilling activity in North America. They said there was potential for this weakness to persist through 2008. Nabors now expects to earn 73-76 cents and analysts had expected 81 cents. This warning is unique to Nabors but the entire sector should suffer. Nabors has warned three times since January and this is getting to be a regular habit. Analysts claim it should mean stay away from North American drillers and service companies but I think it is Nabors specific. New rigs are coming online and they are replacing Nabors contract rigs in the drilling fleet. The Baker Hughes rig count for the U.S. in September was 1,783, down 21 from August. That is definitely not an earth-shaking drop. I have a son who works in the gas drilling business and he is seeing rigs moved to new fields but none going without work. I read in the Rocky Mountain News a couple weeks ago officials in the Rocky Mountain region had approved 127,000 more well sites across Colorado, New Mexico, Wyoming and Utah. That should keep the gas drillers busy for a few more years.

Using my false labor analogy above I think we are getting ready for a delivery. The Fed is not likely to cut rates again given the strong jobs report. Cutting rates devalues the dollar. Cheaper dollars means it costs more dollars per barrel of oil. Once the Fed signals the cuts are over or analysts start doing it for them the dollar should strengthen on our economic strength and that will help push oil prices lower. We also have the +500,000 bpd of oil coming on Nov-1st that OPEC authorized. I suspect it is already being pumped but we won't know that for a couple more weeks. Be patient, without some new development our correction is about to be born.

Two weeks from now I am going to meet with Boone Pickens and I am going to pick his brain on many things including his view on Saudi oil and the falling gas supplies in the Canada oil sands. He is a big investor in the oil sands and I want to ask him if the reported natural gas crunch is real or a smoke screen for other problems. It should be interesting and you will read about his answers right in these pages.

I am closing the RIMM play this weekend. The call spread has reached a point where any further gains from shrinking premiums on the short side could be offset by a retracement of Friday's gain. Let's take our profits and prepare to reinvest them in something else.

Thank you Merrill, Citigroup, UBS, DB, WM, etc. Every time one of those banks said the worst was over and normalcy was returning to the credit markets Bear Stearns spiked higher. Our patience is finally paying off on that position.

The Russell 2000 finally caught fire and our IWM call play is nicely profitable at +64%. I expect the Russell to break out to a new high soon but there could be a testing phase when it reaches 856. Still a nice filler play that is producing profits while we wait for a correction in oil.


November Crude Futures Chart - 60 min

November Natural Gas Futures Chart - Daily

November Gasoline Futures Chart - RBOB Daily

 

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