Option Investor

One Heck of A Week

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June futures closed just over $126 last Friday with expiration of the QM electronic contract on Monday and the CL open outcry contract on Tuesday. The perfect play setup appeared to be short the expiration and ride down the post expiration wave. In hindsight we know that was not a winning plan.

We found out this week in the commitment of traders report that short interest by small investors and speculators in the July crude contracts was at record levels dating back to 1986. Everyone with a futures account thought the play was to short crude at the double event of $130 and expiration. Everyone was rewarded with a monster spike and short squeeze for their troubles. When everyone thinks they "know" the right play and it is the same play it rarely works.

We all know what happened last week only nobody knows why other than blame it on the short squeeze. Crude spiked to a record $135.04 on Wednesday's inventory shortfall. Oil inventories fell by -5.3 million barrels when analysts were expecting only a 900,000 barrel decline. The difference came from a second consecutive week of declines in the daily imports of crude by 700,000 barrels per day. That is a drop of 1.4 mbpd in just the last two weeks. I believe, as in the past, that this is just a timing issue given the 30-45 day transit time from Middle East ports. Eventually we will have a week where all the tankers show up at once and the numbers will correct. However two things are working against us. Refinery utilization has risen +3% over the last two weeks and we are entering the heavy driving season starting this weekend where gasoline demand spikes sharply. This could cause several weeks to pass before inventory levels normalize.

Inventory Table

However, the Dept of Transportation said miles driven in March fell by 11.2 billion over March 2007 due to the high cost of gasoline. That was the largest year over year drop since 1942. Only the oil shocks of the 1970s came close to depressing driving that severely. The -4.3% drop in miles was the first decline in the month of March since 1979. The price of SUVs fell 17.14% from March of 2007 while small economical cars rose +2%. GM and Ford both said they were going to move away from large SUVs and trucks and downsize their lines to smaller more fuel efficient vehicles. That would have been a death knell 4-5 years ago. America's love affair with the automobile has fueled the automakers desire to make bigger and more powerful cars year after year. The Hummer, Expedition and Navigator are examples of major gas guzzler SUVs. All are in for a makeover to smaller versions. The car companies made a lot of money building $60-$75,000 surburban type vehicles. They are going to have to cut that profit to the bone to compete with the $20,000 hybrid from Toyota. Ford said it no longer expected to return to profitability this year and also said there had been a real shift in customer buying habits in just the last three weeks as gasoline moved over $3.75 per gallon.

America's Research Group said customer buying habits were changing dramatically. They found the number of consumers using shopping lists to avoid impulse buying had risen sharply. Consumers were trying to budget $75 fill ups with many commuters filling up twice a week. That is a major expense for already tight budgets. ARG said when gasoline hits $4 per gallon the community screeches to a halt. We have seen $4 gasoline in 17 states and the impact has been the same in all regions. When that $4 level is reached there is an almost immediate halt to unneeded driving.

I am in Dallas this weekend. I left Denver Wednesday in a 2008 suburban with family and several hundred pounds of gear. The roads were almost completely deserted. Other than Oklahoma City and within 50 miles of Dallas there was almost zero traffic. My mother lives on a hill overlooking a major highway in north Texas. The road noise used to be so bad you could not hear a person speaking outside. This week the cars and trucks are so scarce they are almost unnoticed. This is a holiday week but you could not tell it from the traffic.

My wife was broadsided two weeks ago so we took her car insurance rental on the trip. It came from Enterprise Car rental and was a flexfuel car. That is one that burns either gasoline or E85 Ethanol. I have driven about 30,000 miles on road trips over the last two years and have never seen an E85 pump. I am sure they exist somewhere but not on the roads I traveled. I was still impressed with the car and the 18-19 mpg on unleaded gas. I know it does not compete with compact car economy but with extra people and gear it did the trick. If GM can continue this trend to higher mileage vehicles they could attract a new crop of buyers now that economy is all the rage. At $4 gasoline my road trip days are about over. We planned them over the last two years to get them done before the price of gas made them prohibitive. I think that time has come.

$135 oil sure got the media's attention. The $20 rise in just the last two weeks was an event they could not overlook regardless of how introverted they are to local news. The flurry of new price predictions scared many into running oil specials with titles like America's Oil Crisis. The lawmakers got into the act with their inquisition of the CEOs from the top oil firms. When the cameras were turned on it was not the oil companies speaking but a tirade of complaints from every lawmaker while the CEOs sat trying to look attentive. When they were finally allowed to answer a question they were almost unanimous in their fundamental reason for higher prices. That reason was supply and demand. Not enough supply and too much demand.

Drilling in ANWR and off the continental shelf was discussed repeatedly but they are not the answer. If ANWR was opened along with the shelf they would produce at most 2 mbpd total. That is only 10% of our daily consumption and would only impact the price at the pump by less than a dime in the first year with a decrease to a nickel a year later.

The oil story has picked up speed quickly and the timeline is accelerating. I am going to produce a new update to the oil crisis story with some real world "what should we do" content and answers to the hundreds of emails I have received lately. I think I finally have everybody's attention. That update will be out in July. There will be a Peak Oil seminar in October on the West Coast. I will be posting additional info here in a couple weeks. Seating is going to be limited so watch for the announcement if you are interested in attending.

Jim Brown

July Crude Futures Chart - Daily

June Natural Gas Futures Chart - Daily

June Gasoline Futures Chart - RBOB Daily


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