Option Investor

New Highs, New Records

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Short covering in the expiring March futures pushed crude prices to closes of more than $100 on back-to-back days. The new high close was $100.74 and the new all time high was $101.32. Adjusted for inflation the 1979 high would be just over $103 today. The news continued to cause shorts to run for cover as Turkey invaded Iraq on the ground with 10,000 troops. There are fears the conflict could drag on for months and oil output from the region slowed or stopped altogether.

The cold weather in the U.S. was shutting down airports from the Midwest to the northeast and causing heating demands to rise to 30-year levels. Back to back weeks of strong draws of natural gas from storage and the expiration of options on gas futures next week combined to push natural gas prices to $9.15 and a nine month high. Prices were already being pressured higher from the $500 million bearish spread that was closed the prior week by the Saracen Energy fund when they got in trouble.

It was an eventful week in the energy sector with Transocean blowing out earnings with a 70% increase in profits. RIG posted profits of $4.17 including items compared to estimates of $2.54. RIG also guided estimates higher on rising day rates and a shortage of rigs. The company said capex spending would rise to $2.5 billion from $1.4 billion partly due to spending on new rigs. Average day rates for the Transocean fleet rose to $224,000 per day with a new contract announced this week for $535,000 per day for one deepwater rig. That has got to hurt to write a check for a half million a day to drill a well. It makes you appreciate how much money the production companies make from those deep wells. RIG rose +$10 on the news.

Boone Pickens was interviewed on CNBC on Thursday morning and the energy bull said he was shorting both oil and natural gas as we head into the second quarter. Pickens said slowing demand and rising inventories would knock $10-$15 off oil prices in the second quarter. However, he projected $107-$120 in the second half of the year. He was very firm in his belief that we would never see 88 mbpd as projected by the IEA for Q4 of 2008.

Pickens was adamant that the U.S. had to do something to stop the half trillion dollar outflow of cash from the U.S. to OPEC countries each year for oil. He said this massive outflow of U.S. wealth was crippling the U.S. consumer and enriching the coffers of people that hate us. He favors moving to natural gas for transportation and a gasoline tax to force drivers to cut back on gasoline expenditures. The tax money could go to fund new technology for replacement fuels. I personally believe we are very close to a monster gas tax whether applied by the government or peak oil. Gasoline will be double today's prices in the next 3-4 years so just plan on it now.

The OPEC meeting on March 5th is not expected to produce any changes in production quotas. OPEC increased production just before the Asian financial crisis and saw prices fall $10 a barrel over the weeks that followed. With the U.S. teetering on the brink of a recession they are not going to add to production just because oil prices are near $100 and politically incorrect. They don't want prices to go back to $85 or even $90. It is also politically incorrect for them to cut production with prices at $100 even though global inventories are rising by about 10 million barrels per week. They will simply meet and say the world is fully supplied and speculators are causing the price increases. In reality that is true. With the dollar falling crude provides a hedge much like owning gold. As the dollar falls hard commodities rise. It appears everything is working in OPEC's favor and they will not want to rock the boat.

Hugo Chavez said he was not serious about cutting off oil exports to the U.S. or sales to Exxon. Did somebody actually believe him when he made those statements? I seriously doubt it but he had to save face within Venezuela.

If you are going to travel now is the time to do it. Reports out last week claim China's growth is going to cause a rise in jet fuel consumption by 11-13% per year through 2020. That will be a good trick since the world will be hard pressed to produce a 12% increase in fuel each year after 2009. Either way the cost of air travel is going to continue to rise by leaps and bounds until only the very rich can afford it.

I have a friend that works at a major online travel agency in the top 10% worldwide. He said bookings were down 66% in January compared to January 2007. This is due to multiple reasons but part of it is the increase in travel costs. They are afraid the price of oil will continue to limit travel in the coming years. I was actually shocked that anyone in what I call the general public was even aware that we were moving into a period where air travel would be phased out for the working class. I am glad to see that there are independent thinkers and observers still operating in the business world. By far the vast majority of people I come in contact with look at me like I am explaining an alien abduction rather than the reasons they will be paying $6 for gasoline soon.

AAA reported that diesel rose to a record of $3.503 per gallon in the U.S. last week and it is not even summer yet. Gasoline futures hit $2.62 on Tuesday despite gasoline inventories being at 14-year highs of 230.3 million barrels. Crude inventories rose by +4.2 million barrels stretching to six weeks the consecutive inventory builds. Supplies have increased by 22.6 million barrels over that six-week period. Capacity utilization fell to 83.5% as refiners took capacity offline rather than produce excess gasoline and depress prices. Gasoline inventories rose for the 15th consecutive week.

All those statistics sound bearish for crude prices but that is not the whole story. Crude inventories are still 4.9% below last year's levels. Distillates are 6.8% below the same period in 2007. Only gasoline inventories are above last year's levels by 4.0% due to slowing demand due to high prices and is nearing a 2-year low. Despite the drops in crude and distillates the rising excess in gasoline should be a prime reason for prices to fall.

For a dismal week in the markets we had a pretty good week in the LEAPs portfolio. Only one stock lost ground and many of the rest were big movers. We paid the price in the market drop but being invested in the right stocks when the gains return makes it all worthwhile.

Jim Brown

April Crude Futures Chart - Daily

March Natural Gas Futures Chart - Daily

March Gasoline Futures Chart - RBOB Daily


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