Option Investor
Commentary

$117, Do I Hear $120?

HAVING TROUBLE PRINTING?
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May futures closed at $116.97 on Friday as news of more violence in Nigeria helped to crush the shorts for another $2 gain. There is no fundamental reason for oil to be this high but I have already said that about 117 times over the last two months. When the momentum players are in control there does not need to be a reason. It is just highly frustrating trying to pick plays on fundamentals when fundamentals don't matter.

In Wednesday's inventory report crude dipped slightly for the second week but remains well stocked. Gasoline fell another 5.5 million barrels stretching the 5-week decline to something in the 20 million barrel range. On the surface that appears very bearish but as I explained Thursday night that is due to refiners trying to flush the winter gasoline out of the system and at the same time trying not to refine the summer blends for a loss. Refinery utilization fell to 81.4% and a 16-year low. If we needed gasoline there is plenty of oil and plenty of capacity to create it almost instantly. But that would be a fundamental point that nobody cares to hear.

EIA Inventory

In Nigeria the Movement for Emancipation of the Niger Delta (MEND) said they had attacked a major pipeline feeding the Bonny export terminal. This is the largest terminal in the country with storage for 7 million barrels of oil. There was no report on the extent of the damages but any sentence that contains the words attack and pipeline is good for a $2 spike in oil prices. Nigeria has had over one million barrels of oil per day shut in for most of the last year due to violence. The group wants a share of the oil revenue to cease their attacks. Nigeria is the 3rd largest importer to the U.S. of light sweet crude.

Gasoline prices hit $3.418 per gallon on Friday and a new record. No surprise there. Many states are reporting prices over $3.65 with the west coast around $4. I explained the reason for the price spike in May in Thursday night's email. Basically for those that did not see it the gasoline blends change on May 1st to conform with EPA rules. During the winter refiners can sell generic gasoline to any region. Beginning on May 1st each region requires a specific blend to reduce heat evaporation and emissions. The gasoline must be blended with other ingredients like ethanol to comply with the rules. It becomes branded for a specific region and the cheaper generic blend goes away. Without the generic competition the refiners can get more for their products and dealers have to buy from a specific source to meet the rules.

The drop in gasoline inventories is due to one thing. The gasoline in the system on May 1st must conform to the May blend requirements. All generic winter gasoline must be out of the system. With demand down the only way to flush the system is to put very little gasoline in it. With consumption around 9 mbpd it would take 24 days to drain the system. Of course we can't afford to actually drain it and start over so the refiners are only putting in the bare minimum gasoline needed to keep everything flowing. They are now putting in the more expensive summer blend to flush out the remaining winter supplies. In theory on May 1st every pump will be dispensing a summer blend but I would be very surprised if it ever worked out that way.

BP announced its Thunderhorse production platform in the Gulf of Mexico would finally be online by the end of 2008. You may remember that the platform was nearly sunk by Katrina and suffered hundreds of millions in damage. BP said it would be a powerful symbol of a change in the BP philosophy when it begins operation. BP said it would be one of 25 projects that would come online between 2007-2009 that would add 650,000 bpd of new production.

The new projects would continue through 2012 with projected total BP production of 4.3 mbpd. Looking forward the CEO said BP was committed to maintaining that 4 MBPD production until at least 2020. BP is changing its business model, again. They have decided to sell their retail outlets in the U.S. and numerous other non-core assets to focus on only two things. Those are Exploration and Production and Refining and Marketing. They plan to cut corporate overhead by 15-20% by laying off management and eliminating unnecessary internal processes. BP has been criticized for the last couple years for being in a "run out" phase. That means they were not growing and were focused on simply producing existing reserves and buying back stock as the company grew smaller. This suggests they have found a backbone again and are going to try and survive in the competitive climate. BP claims it has secured new opportunities in Algeria, Oman, Libya, Colombia, Pakistan and in Canadian heavy oil. They remain under the gun in Russia where they are one of the few "partners" that have remained partners and not slaves. They operate the TNK-BP field. Maybe it is time to rethink a play on BP.

I think we are getting close to an entry point on some energy plays. If the May crude futures expiration follows the trend of the April expiration we could have a significant drop in oil prices by next Friday. May futures expire on Tuesday. In the April cycle in March the price of crude fell -$10 within 48 hours after expiration. The CFTC said open interest in crude futures rose 40% over the last two weeks and that suggests a lot of new short positions. Those May positions will have to be closed by Tuesday.

May Crude Futures Chart - Daily

"Deathanol" may finally be on its last legs as a mass-produced biofuel from corn. 33 countries are experiencing food riots and we are burning corn for fuel. This has not escaped notice of many nations and the U.S. is under fire to halt the process. There are many factors relating to the growing world hunger and only one is from corn based ethanol. A 5-year drought in Australia has virtually shutdown rice production that fed 20 million people. Droughts in Africa have reduced crop sizes of several different feed crops. Wheat prices have risen 120% over the last year. Rice, a staple food for nearly 2 billion people is up 75% in just the last two months. The World Bank estimates that on average food prices have risen 83% over the past three years. According to the World Bank president "the U.S. and Europe have been focused on filling their tanks while the rest of the world was trying to fill their stomachs." Fertilizer prices have risen several hundred percent over the last 3 years. We may have reached the carrying capacity of the planet. Corn ethanol may have been doomed from the start but this is just one more reason to give up this folly.

Boone Pickens has changed direction again. He was widely quoted saying oil prices would go down last month. He was shorting oil at the time. He admitted last week that he made a mistake and he had covered his shorts and was long again. His fund fell 21% in Q1 because of his shift from long to short. Pickens said he could see $125 oil and would eventually reach $150 but gave no timeline. He said world production will not exceed 85 mbpd because of high depletion rates on existing fields. We are actually expecting demand to be 88 mbpd in 2008 and 89.6 mbpd in 2009. The difference between Boone's 85 mbpd number and current demand is natural gas liquids (NGLs) and refinery gains. When refiners crack a 42-gallon barrel of oil they end up with something close to 48 gallons due to processing gains. Remember they add stuff to it to make the specific regional blends. In California they end up with 49.59 gallons because they add even more components to cut emissions.

Jim Brown

Sign of the times cartoon

May Crude Futures Chart - Daily

May Natural Gas Futures Chart - Daily

May Gasoline Futures Chart - RBOB Daily

 

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