Option Investor
Commentary

Bear Market In Everything

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It was one of those weeks where you didn't want to open your charts. Good companies were getting pummeled for no reason other than the market wanted to go down. Fears of a recession were on every airwave and that was the only cause for profit taking.

Crude oil futures closed on Friday at $90.57 after a $10 drop over the last two weeks. It was the same story just a different sector. The broader market was selling off and commodity investors are still market driven. The 8-week string of inventory reductions finally came to an end and you would have thought they struck oil on the lawn of the White House. After seeing draws of 32 million barrels over 8-weeks a sudden gain of 4.3 million barrels was treated like a complete reversal when it barely covered two thirds of the prior week's 6.7 million barrel decline. We knew it eventually had to end and traders were just waiting for the news so they could take profits. The news that refinery utilization fell from 91.3% to 87.1% was lost on the crowd. If you take 4% of refinery capacity offline for a week that would mean 6.16 million barrels did not get refined. (22mbpd x 4% = .88 mbpd * 7 days = 6.16 mb) Since inventories only rose 4.3 mb it still represented a drop of nearly 2 mb in real terms. I know that is confusing but trust me, it will be resolved in next week's inventory report.

Another factor pushing prices lower was the pending expiration of the February crude contract next Tuesday. Traders were forced to take profits on the down market rather than holding for the recovery. The March contract is only trading a few cents behind the expiring February contract so there should not be any material expiration pressure on Tuesday.

We are starting to hear comments out of OPEC regarding the Feb-1st meeting. They appear unanimous that there will be no increase in production if it is not needed and according to them it is not needed. With March a low demand month they do not want to add extra production just as demand is slowing from the end of the northern hemisphere winter. I am sure they are complaining internally that $100 oil did not stick.

Another factor pushing prices down was an estimate cut for 2007 world oil demand to 85.8 mbpd by the IEA. Why cutting estimates for 2007 would have any impact on current prices is beyond me. They also left virtually unchanged the forecast for 2008 demand to be 87.8 mbpd. This "virtually unchanged" number is actually 120,000 bpd below their upward revision just a month ago. Either way the 87.8 mbpd number implies a 2.3% year-over-year growth when many other estimates are only suggesting 1.5% growth. According to the IEA world supply was 87 mbpd in December. FYI - Boone Pickens and several others have said the world will never produce 88 mbpd. That puts us VERY close to decision point unless they are proved wrong.

Natural gas prices continue to hold around $8 due to the waves of cold weather producing strong draws from gas in storage. This is only temporary and we should see a decline back to $7 as we near the spring thaw. Amazing how quickly time flies once the holidays are over.

Schlumberger (SLB) stunk up the place on Thursday when they reported earnings that rose 22% but fell about a nickel short of analyst estimates. The problem was lower margins on land drilling, primarily gas wells, in North America. Gas drilling Canada has fallen off a cliff since they changed the tax rates. This is impacting all the service companies that have operations in Canada. SLB gave an upbeat long term forecast but the stock was hammered.

It was a bad week for the portfolio. We expected selling once into 2008 as traders took profits in a new tax year. Last week was worse than that with the big winners taking even bigger losses. There was no specific reason other than the beginning of bear market sentiment as recession fears grow. SLB added to the decline rate with their earnings miss. I was shocked by some of the declines in what should have been bullet proof stocks. For instance FLR -26, MOS -19, FWLT -11, NOV -10 and PBR -16. Nothing really changed except for market sentiment.

We were stopped out of nearly everything that had a posted stop and I wish I had posted a stop on several others. $26 moves are well outside any semblance of normal.

What this did for us was give us some more profit opportunities. Several of the stocks we play have declined to significant support levels and we will be entering some put spreads to capitalize on these drops. Other plays we will be increasing our positions to take advantage of the cheaper prices and some that were stopped out we will be putting back on the watch list for potential reentry.

Jim Brown


FFebruary Crude Futures Chart - Daily

February Natural Gas Futures Chart - Daily

February Gasoline Futures Chart - RBOB Daily

 

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