Option Investor

Not Alarmed!

Printer friendly version

The press could not mention often enough how crude fell -2.75 on Friday to close at $89. You would have thought it was $59 instead of $89. The drop was directly related to the OPEC meeting and the lack of any language suggesting they could cut production at the March meeting. Rest assured there will be comments from OPEC about potential production cuts if prices decline much further.

Long time readers know that the end of February and early March is typically a weak demand period for crude. The winter is leaving the Northeast and demand for home heating oil begins to drop. Driving has not picked up yet but will once spring weather appears in April. Because of this seasonal demand decline March is normally a weak period for crude prices. Refiners are going offline to switch from winter fuels to summer fuels and crude inventories rise. Once past March the summer demand season begins and prices should rise until the same cycle is repeated in September/October. Only that one is complicated by hurricanes.

Because we are entering the weak demand cycle we should expect some further weakness in crude prices. Support is currently about $87 and we could see that broken. If the U.S. markets continue to rally and recession fears ease over a solution to the bond insurer problem we could see oil prices move up again very quickly. Most of the movement on oil is based on perception rather than real numbers so the perception that a recession has been avoided will have IEA/EIA/OPEC raising their demand estimates and that will support higher oil prices. Lastly, if crude does begin to slip I do expect OPEC to start making comments about production cuts at the March meeting in hopes the comments will support prices.

Exxon and Chevron both reported earnings on Friday and there were plenty of differences. Exxon reported a profit for Q4 of a whopping $11.7 billion. That was about a billion more than their prior Q4 record back in 2005. Their full year profits were a hefty $40.6 billion and a record for any U.S. corporation. Their profit was almost as much as Microsoft offered for Yahoo. Full year revenue for Exxon totaled $404.5 billion or about what the Defense Dept spends each year. Exxon produces only about 3% of the world's oil. Exxon had a capex budget of $21 billion in 2007. They put the majority of their profits right back into exploring for more resources.

Chevron posted quarterly profits of $4.88 billion and full year profits of $18.7 billion and a record year for Chevron. Crude hovered around $90 for most of the quarter and about 50% higher then the prior year. That helped to fill their coffers with plenty of exploration bucks. Chevron saw profits on the refining side fall -79% due to the low crack spreads and higher royalties and Chevron also got a failing grade for reserve replacement. Analysts always look for something in excess of 100% to see if the company is going to continue to prosper in coming years. Chevron only managed a 10% reserve replacement in 2007. Exxon will not release their numbers for several more weeks. That was Chevron's 4th consecutive year at less than 100%.

Neither company issued a forecast but Chevron said major project delays would lower its 2008 production by about 150,000 bpd to 2.65 mbpd.

You may remember a couple weeks ago I reported on a memo from the Shell CEO to his employees about the end of easy oil. Nobody in an oil company ever uses the term Peak Oil but they can say the "end of easy oil." The forecast was pointed to the next 2-3 years as critical and after 2010 as becoming increasingly a problem to find and produce new oil. This week it was the recently retired CEO of Talisman Energy, Jim Buckee. Being recently retired frees a lot of tongues and Buckee was being interviewed on ABC radio from Perth Australia. The bottom line on the interview was "peak oil is here or hereabouts" meaning now or very soon. His outlook was for price stress again in Q3/Q4-2008 with crude prices reaching $150 or higher. The conversation continued with talk about what that was going to do to civilization in U.S. cities. Our cities built over the last 50 years typically have your residence at point A, your work at point B and where you shop at point C and all those points are miles and miles apart. Once gasoline rationing appears (either by law or price) that type of lifestyle is going to cease to exist.

Mexican officials confirmed an earlier prediction that production from Cantarell would likely drop another 200,000 bpd over 2008 to something in the range of 1.06 mbpd by year-end. Cantarell production was 1.26 mbpd in Dec-2007 and that was the lowest level of the year and a 16% decline. They are predicting another 16% decline in 2008. Elsewhere Chevron said major project delays would cut 150,000 bpd off their expected production. Another note from a big field in the Gulf was a 12-18 month delay of production start on another 150,000 bpd. Shell reported with their earnings that production fell for the 5th straight year and forecast that 2008 production would fall again. Production fell to 3.32 mbpd in 2007 from 3.47 mbpd in 2006. They reported 11 "material discoveries" in 2007 and added reserves of 1 billion barrels according to their report. However, according to the report some of those reserves must be "verified" before they can be counted. What a pile of crap. So far 2008 is not shaping up to be a banner year on the production side.

Gasoline prices are already expected to be over $4 per gallon on the coasts this summer. Be ready to pay up if you are going on a vacation by car.

Thank you Flowserve! We were rewarded on Friday with a +$14 spike in Flowserve (FLS). The company issued a press release raising guidance and bragging about how good business was for them. Bear Stearns took the bait and upgraded them to a buy. Shorts were squeezed and the rest is history. We just entered the FLS position past week.

Jim Brown

March Crude Futures Chart - Daily

March Natural Gas Futures Chart - Daily

April Gasoline Futures Chart - RBOB Daily


Leaps Trader Commentary Archives