Option Investor

Year End Volatility Ahead

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Crude futures rose on Friday to close at $98.30 and are showing no signs of weakness. Every dip is bought and even news of rising shipments failed to produce selling. Oil tracking firm Petrologistics said on Thursday that OPEC shipments for November have risen to 31.573 million barrels per day from 31.249 mbpd in October. This jump of 324,000 bpd was fueled by a strong recovery in production in Iraq. Iraq exports have reached 2.605 mbpd compared to 2.146 mbpd in October. Using my math that is an increase of 459,000 bpd from Iraq alone.

Does this strike anyone else strange that OPEC agreed to raise production by 500,000 bpd on November 1st and even with 459,000 bpd coming from Iraq, which does not even have a quota at present, they could only manage an overall gain of 324,000 bpd? That means the rest of OPEC actually lost 135,000 bpd instead of increasing 500,000 bpd. This is not an encouraging trend especially with prices at $98. You would think cheating would be rampant and OPEC would be dumping oil on the market. That is not happening according to the numbers.

Upon further research I found that the United Arab Emirates (UAE) suffered a drop in production of 452,000 bpd due to maintenance problems at three major offshore fields. Angola also saw production fall 101,000 bpd.

According to Petrologistics Saudi is coming to the rescue of OPEC's lagging shipments and is boosting production by 720,000 bpd for the four weeks ending Dec-8th. This will offset the production drops in Angola and the UAE as well as some minor declines from some other OPEC members. The majority of this Saudi oil is destined for the U.S. and that should solve the declines in our inventory levels.

The market is quick to realize OPEC is not shipping as promised and outages and falling production from OPEC members is more transparent then in previous years with multiple oil trackers using every available means to clarify actual shipments.

This boost in shipments from Saudi Arabia headed for the U.S. suggests there will be some volatility in oil prices very soon. It takes several weeks for Saudi oil to reach the U.S. but reportedly those increased shipments began on the 12th. That means oil inventories should jump sharply around Dec-12th and continue for four weeks. That is almost exactly when refiners, pipelines and storage facilities will want to be reducing inventories to avoid taxes on inventories that are charged on Dec-31st. Prices paid for crude in mid December will have to reflect the potential taxes that will be charged to whoever is holding on Dec-31st.

The next saga in the OPEC story will happen on Dec-5th when OPEC meets to discuss production levels in Abu Dhabi. You can rest assured that Saudi Arabia is going to be even more forceful than before in lobbying for another production increase to slow the price of oil. I will be shocked if we don't see $100 before the meeting but after the meeting I would be looking for prices to drop ahead of tax time regardless of any production decision other than a cut. I would not be surprised to see prices drop like a rock once $100 has been hit but some analysts are now predicting $110 or even $120 before the year is out. Analysts are expecting OPEC to agree to another 500,000 bpd increase in production on Jan-1st but given their recent history of failing to follow through on the Nov-1st 500,000 bpd I doubt there will be many believers until it starts backing up in the pipelines at Cushing Oklahoma.

Crude demand is expected to rise to 87.6 mbpd in Q4, up from 85.5 mbpd in Q3. Many analysts and investors including Boone Pickens feel we will never see 88 mbpd of production. The decline rate being discussed for current production at the recent oil conference in Houston was over 5% per year and that is as sure as the tick of a clock. That is 4.3 mbpd in declining production every year without fail. This also means 4.3 mbpd of new production must be brought online every year to offset that drop. We are simply not seeing that kind of new production brought online and surely not enough new production to continue to supply growing demand. $100 oil, bet on it but I do expect an eventual decline as demand slows in Q1.

On the portfolio side we only had two casualties last week and that was the FXI and CCJ. Thursday's big drop triggered the stop loss on the FXI and it rebounded 9 on Friday. Some of the Asian indexes are down well over 10% and even though we caught this on a dramatic dip there was still some selling to come. CCJ continued its four-week slide and hit the stop at $40 on no news.

Transocean (RIG) is scheduled to complete its merger with Global Sante Fe (GSF) on Tuesday. We will be entering a position on RIG once the merger is completed and the stock is repriced. S&P said on Friday RIG will remain in the S&P but the weighting will change. I will update RIG next weekend with entry levels.

The oil sector appears to have firmed although further drops in the broader market could continue to create weakness in the individual stocks. Fortunately crude has remained in the high $90s but I fear we are going to see that support tested soon. Do not be afraid to close a losing position. It is not an admission of failure but simply a retreat until support reappears. If we do get a sharp downdraft in December I would use it as a buying opportunity rather than an excuse to dump stocks.

January Crude Futures Chart - Daily

December Natural Gas Futures Chart - Daily

December Gasoline Futures Chart - RBOB Daily


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