Option Investor

Another Fun Week For Oil Bears

Printer friendly version

I am beginning to think there is a vast right wing conspiracy preventing oil prices from declining. Wait, somebody already used that excuse so I can't use it. I have to admit it was almost funny watching the Chief Economist from Tesoro on CNBC claiming oil was only worth $60 today. Of course he was as dumbfounded as the rest of us as to why oil continues to rise in the face of nearly everybody on the planet claiming there is plenty of oil.

Lynn Westfall said they can buy oil in any quantity and from anyone and there is no shortage. Because they don't do long-term contracts preferring instead to just buy it on the liquid market as needed Lynn said they would be the first ones cut off from supply if there was a shortage. Those refiners with long-term contracts would continue to be supplied at least theoretically. He said people they have never bought from are banging on their door every day trying to get Tesoro to buy oil from them. Lynn was emphatic in his claim there is no shortage.

That was Thursday night and oil had just touched $90 again. On Friday crude spiked to 92.22 on the new U.S. sanctions on Iran, new attacks and shutdowns in Nigeria, Lebanese troops firing on Israel planes and Turkey bombing locations inside Iraq. It was a fun night in the oil world!

The key really appears to be Iran. Each day brings us closer to a confrontation with Iran or at least a blockade of Iranian oil. At least that is the perception in the markets. We all know in trading it is the perception that matters most. In this case investors may eventually be right about the conflict but it remains to be seen if they can stay invested until proven right.
According to Mr. Westfall hedge fund speculators betting on the geopolitical concerns are driving up the prices by investing billions in the futures. He felt this was a quarterly event and once oil prices stalled we could be in for a sharp decline as these funds jam the exits to capture their profits.

You may have noticed that despite the +$12 spike in crude over the last three weeks that some oil companies have not followed the price higher. Crude took off on Oct-11th and Exxon hit a high of $94.25 that day. Since then XOM has declined to 89.67 early last week and then rebounded slightly to 91.92. Oil went up +$12 and XOM fell -2.25 over the same period. Chevron hit a high of $92.25 on the 11th and then declined to trigger our entry at $87 on the 22nd despite crude exploding higher.

The problem here is the shrinking crack spreads and some poor earnings guidance from several energy companies that already reported. Oil hit $92 on Friday but refined gasoline was selling for $95.50. The $15-$20 crack spreads from early in the summer have declined to only a couple dollars today. Refiners are making relatively little money at the current price. One analyst said on Friday that refiners will slow production eventually rather than sell gasoline for a loss. The problem is the lack of demand for gasoline. This may already be happening since gasoline inventories fell by 2 million barrels last week.

Crude imports fell a whopping 1.3 mbpd over the last week suggesting refiners are cutting back on their purchases until the price imbalance corrects. Capacity utilization fell back to 87.1% last week. The refiner market and the inventory levels are trying to tell us there is an artificial imbalance in progress. Gasoline inventories are 7.1% below 2006 levels but gasoline prices are only about 20 cents higher. Crude was $66 this time last year and at $92 today that is a 40% increase or $26. You would think a $26 increase in crude prices would produce more than a 20-cent increase in gasoline prices. Under normal supply and demand conditions the ratio between crude prices and gasoline would be relatively constant. These are not normal markets. Using the same ratio as in October 2006 gasoline futures should be about $3.20 now instead of $2.27.

On Friday Kirk Kerkorian announced a bid to buy 20% of Tesoro at $64 a share. Either captain Kirk has finally gone senile or he knows something we don't. Does Kerkorian think gasoline is going to $3.20 to reinflate the crack spreads? Several analysts spoke in unkind words about his bid while a lone Goldman Sachs analyst agreed with Kerkorian that refiners were undervalued. Something smells here and I am not downwind from a refinery. I removed TSO from the watch list.

Earnings from several companies produced a drag on individual stocks. Grant Prideco reported earnings that missed estimates due to charges for consolidation of production into a new facility. Earnings were 96 cents compared to 95 cents in Q3-2006 and analyst estimates of $1.01. Revenue rose 43% and offset most of the consolidation charges. They raised estimates for Q4 to $1.10 compared to analyst's estimates of $1.01. The stock was pummeled to a new 7-month low at $48. This might be a buying opportunity but I would rather not catch a falling knife today.

Baker Hughes hit a high just over $100 on the initial oil price spike but fell to $88 on Friday after just "meeting" analyst estimates for earnings. Various analysts said rising costs at BHI and in the industry were going to be a problem and criticized the 21.8% operating margin at BHI. Revenue was up +16% and profits +9%. Analysts better get used to rising costs since everything in the oilfield is going up. Rigs cost more, pipe costs more, labor is more expensive and much of the equipment is on backorder. This is not a recipe for decreasing costs. It is also another reason oil companies in general are not surging on the spikes in oil. Lots of earnings warnings and misses and the quarter is still young.

We were successful in entering three new positions last week. The drop in crude on the 22nd was only -$3 and short lived but the drop in energy stocks was worse in some cases. The Schlumberger earnings the prior week weakened the service sector and the drop in crude pushed SLB and OII to our targets. The shrinking crack spreads pushed Chevron to $87 and our entry at the same time. I was hoping the drop would continue so we could capture a couple more but it was not to be. I am still trying to avoid chasing these stocks. If we ever do get a correction in crude it could be a monster and the individual stocks could be hammered. We just need to bide our time and wait. Missed profits are better than lost money every time.

December Crude Futures Chart - Daily

November Natural Gas Futures Chart - Daily

November Gasoline Futures Chart - RBOB Daily


Leaps Trader Commentary Archives