Option Investor

Do I Hear $100

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It was a great week for shorts. At least it was for shorts in the financial sector. I went to bed Tuesday night with 4 points in my pocket only to wake up Wednesday stopped out and naked. The volatility in crude futures is beyond belief. The monster swings and intraday ranges are leaving both bulls and bear as road kill in their wake.

On Wednesday the December contract hit $96.24 before dropping $4 to $92 at the open. After Friday's close crude climbed back to $96 for a second test of that level. Were it any other time of the year or a different commodity I would be looking at $96 as a double top but I believe we are destined to hit $100 and possibly even higher.

The geopolitical concerns are heating up again. On Friday the news pushing oil higher was a U.N. decision to draft some new sanctions against Iran to pass in November if Iran does not cooperate better with the International Atomic Energy Agency (IAEA). The news articles predicting a U.S. attack on Iran are becoming more numerous and even though the experts claim not a chance the public, including traders, seem to think it is a distinct possibility.

Also adding to the upward pressure was news that the +500,000 increase in production from OPEC slated to begin on November 1st could be delayed by ongoing maintenance at some Middle East fields. I know, you can't make this stuff up. It sounds like a conspiracy novel filled with international intrigue.

Hurricane Noel was also said to be complicating the picture. Evidently the tanker stream heading into the gulf was delayed for several days as Noel crossed from below Cuba through the Caribbean and past the Bahamas. This excuse I believe because no tanker captain is going to drive right through a hurricane and face being put in jail for spilling a million barrels of oil on some Caribbean beach. I am sure there was a parked flotilla of tankers well away from the storm just biding their time. That could easily cause another decline in crude inventories on Wednesday and be the catalyst for tagging $100 for the first time.

You would think $96 oil would be generating massive profits for the oil companies. Unfortunately as we saw last week that was not the case. The high oil prices during a period of slack gasoline demand created a serious squeeze in the crack spreads. That is the difference between what a refiner pays for oil and what they received for the refined products. Using raw numbers the profit on a barrel of oil declined to under $5 last week compared to over $20 several months ago. The crack spread shrinkage is producing profit shrinkage at the refiner level and that includes most of the large integrated producers.

Exxon (XOM) profits fell -10% for its biggest year-over-year decline in three years. Exxon said the cost of crude rose faster than the price of the products and earnings fell by more than $1 billion. Don't feel sorry for them they still pocketed a little over $9 billion in profits for the quarter. Exxon also reported a drop in crude production but that was swept under the carpet in the press releases. Production fell by -2% but if you factor out lost production from being kicked out of Venezuela, OPEC quota cuts, divestments and entitlements production actually rose +3%. Let's see if I understand that. If production in the comparison quarter was 100 barrels and I only produced 98 barrels this quarter then how did my production rise +3%? Obviously I am playing word games here but you get the idea. Production fell. Period. You can put lipstick on it but its still a pig. Exxon attempted to buy its way out of an earnings miss by repurchasing 90 million shares of its stock during the quarter. That is nearly a billion dollars of stock and it increased their earnings per share but not enough to keep them out of trouble. Their 5.4 billion outstanding shares made that a losing proposition. Personally buying 90 million shares a quarter instead of using the money to find and produce more oil is proof that the opportunities for profitable exploration don't exist.

Exxon reported that the Alabama Supreme Court through out a $3.6 billion judgment against Exxon for allegedly underpaying the state royalties for drilling in state waters off the coast. The ruling was 8:1 so this effectively ends the case with only a minor $51 million payment for compensatory damages. I would say that was a big win for Exxon. We were triggered on our Exxon entry when Exxon hit $88 on Thursday.

Chevron (CVX) reported earnings that fell 26%, the steepest decline in five years, to $3.72 billon. Analysts had been expecting some profit shrinkage from $2.29 to $2.07 per share but the $1.75 Chevron posted surprised everyone. Chevron actually lost $110 million in its U.S. refining division. Chevron lost some profits due to refinery fires including one in Mississippi that will not fully reopen until next year. Chevron also saw production slip by 100,000 bpd to an average of 2.6 mbpd. 100,000 bpd x $95 = $9.5 million per day in lost production revenue. Of course some of that was made up by higher prices received on the 2.6 mbpd they did produce but falling production is still the key here.

ConocoPhillips (COP) profits fell to $3.67 billion from $3.88 billion on a $2 billion drop in revenue. Still Conoco managed to repurchase $2.5 billion in stock during the quarter. That equates to about 30 million shares of the 1.6 billion outstanding or just under 2%. That increases their earnings per share by roughly 9 cents meaning their actual earnings per share using the prior outstanding share amounts was 9 cents less than they reported or a miss of -3 cents compared to a claimed beat by +6 cents. A J.P Morgan analyst said their actual earnings were only $1.94 per share after special items instead of the claimed $2.23 per share. Analysts were expecting $2.17 per share. COP said it expected to purchase another $3 billion in shares in Q4. Because of the earnings sleight of hand COP shares did not decline out of their current $85 range. That is a good trick if you can do it. Unfortunately if you are making $3.67 billion per quarter and buying back $3 billion in shares instead of putting that money back to work you will eventually run out of production and the charade will end. On the plus side COP said production should increase 50K to 60Kbpd in Q4. That is not from new exploration but from units returning to production after a summer maintenance cycle.

Sunoco also reported falling earnings from lower production, margin shrinkage and refinery outages. They still managed to buy back 2.8 million shares and continue their own earnings shell game.

On the positive side of the earnings ledger Occidental (OXY) posted earnings that jumped +13% compared to most estimates predicting a decline. OXY posted earnings of $1.58 per share compared to analyst estimates of $1.31 per share. OXY managed to pull off this surprise by increasing production by +7% to 570,000 boe per day. Finally, an oil company that is actually producing more oil instead of spending the money on their own stock.

Hess Corp (HES) missed analyst earnings estimates of $1.36 when they posted only $1.23 in earnings. Same story here with refining margins knocking over $100 million off earnings. HES did manage to increase production by 5,000 bpd to 357,000 bpd.

Captain Kirk may be rethinking his Tesoro acquisition strategy this weekend after TSO fell nearly $10 per share when earnings declined by -83%. The refiner said high oil prices crushed margins and knocked refining profits from $274 million to only $47 million for the current quarter or 34 cents per share. Analysts had been expecting 83 cents. The stock price fell back to $56 even with Kerkorian's announced decision to offer $64 per share for a 20% stake in the company. Not a fun week for Kerkorian. He should have no trouble getting investors to sell him stock for $64 today.

With oil and gas prices rising daily you would think Canada would be celebrating. Instead Alberta is raising taxes on exploration and production companies to the point where drilling which has already slowed will slow even further. Canadian Natural Resources (CNQ) said they would drill as many as 50% fewer wells in Alberta due to the planned royalty increases. This view is going to be the same for most Canadian exploration companies. The new tax structure is different for nearly every well drilled depending on the depth, flow rate at completion and price or oil and gas when it is produced. As prices go higher the royalty percentage goes higher as well. This is a clear example of taxing run amok and squeezing exploration companies and forcing them to drill elsewhere. We have already seen drilling activity fall in Canada as gas prices softened and the tax plan was being discussed. The service companies, SLB, HAL and NBR all warned that revenue was slowing in Canada due to decreased drilling activity. Looks like it will slow even more in the future.

In the Gulf of Mexico several service companies, SLB, HERO, BJS, etc, have said there is a profit squeeze underway due to lower activity levels and less production on completed sites. Roger Read, managing director of Natixis Bleichroeder, said the sector has been absorbing higher operating expenses in the Gulf of Mexico as energy properties become more mature. This is a key sentence: Read said, "The average discovery has dropped by 50% to 60% over the past five years, and costs have almost tripled."

I am starting a new section this week for covered calls using LEAPS. On some of these stocks the LEAP premiums are so large that it makes sense to buy the stocks and sell the leaps. The return on the investment can be very nice with very limited risk. It does require a little more capital but time works in our favor. I am going to start offering some naked LEAP puts on some positions over the next couple weeks. That is the same as a covered call only we won't buy the stock.

December Crude Futures Chart - Weekly

December Natural Gas Futures Chart - Daily

December Gasoline Futures Chart - RBOB Daily


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