Option Investor

Holding Our Breath

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By the time you read this the Saudi Oil Conference should be in full swing. Oil traders are holding their breath to see which way to trade on Monday. The price of crude has been stagnant in a range around $135 for the last two weeks as the tension built ahead of the meeting. Nobody has a clue what the meeting holds since this is the first of its kind. Anything is possible and I would bet that oil prices are going to be a long way from $135 by next weekend. The only and most important question is which side of $135?

The weekly oil inventory report showed another drop in crude stretching the string to five consecutive weeks and a loss of 25 million barrels. Gasoline inventories fell as well as refiners cut back on refining the high priced oil from the prior week. Gasoline imports also declined. Crude inventories are now 14.2% below year-ago levels. All of this is just smoke and has no relevance on oil prices this week as traders await Jeddah.

Weekly Oil Inventory Table

The stage is set and Saudi officials are making what seems like hourly statements to the press. They leaked the news they were going to increase production again by 200,000 bpd early last week. On Friday they confirmed it in the press. They also reiterated they were spending $90 billion to boost production to 12.5 mbpd by the end of 2009. There are many skeptics on that point and doubts abound but that is a year away.

Bloomberg said Saudi pumped 9.134 mbpd in May according to OPEC. Bloomberg said their output was 9.25 mbpd. Last Month Saudi said they were going to start pumping an additional 300,000 bpd within a month. Now they have confirmed they will add another 200,000 bpd on July 1st. In theory and using the Bloomberg 9.25 mbpd as a starting point that puts them at 9.75 mbpd and 11% of total daily demand. It also came to light last week that the 200,000 bpd increase to be announced at the meeting is only temporary for the month of July and that was not met with cheers. It only heightened the rumors that Saudi is close to its peak production.

The current rumor is that Saudi will announce an increase of 500,000 bpd at the meeting rather than the already admitted 200,000 bpd announcement. This rumor caused prices to weaken on Friday after the Israel/Iran spike back to $137. Personally I think the rumor mill and the various translation problems have created this out of thin air. The combination of the 300,000 announcement last month and the 200,000 announcement this weekend is 500,000 and I could easily see how being overheard saying something like "We are going to increase production by 500,000 bpd" could be translated or construed by headline hunting journalists as an additional 500,000 when it is not.

The EIA is no helping with the rumors. They calculated that 2008 world production would average 86.54 mbpd and consumption total 86.38 mbpd. Since consumption varies greatly by season that is an overall average. They claim global production even with the 500,000 already announced by Saudi would still fall short by 750,000 to 860,000 bpd during the peak season. They feel that another 750,000 bpd is needed to cool off speculation in oil prices and meet the peak demand.

Saudi responded to those comments by reiterating they were currently spending $90 billion to improve production to 12.5 mbpd in 2009. The two remaining projects that will contribute to that goal are the 500,000 bpd Khursaniyah field, originally slated to come online last December but has been experiencing continued delays. The last and even more complicated 1.2 mbpd Khurais field should be online by mid-2009 according to Saudi. Literally nobody believe that claim but again, that is a year from now.

The only reason I spend so much time talking about Saudi is because they are the only OPEC country with any meaningful excess capacity either real or imagined. The key point to this entire exercise is how much oil can they really produce? If they can pull off 9.75 mbpd it would help the overall problem but remember most of that is low quality crude already in a surplus.

The world is holding their breath hoping this weekend meeting will somehow magically fix the high prices on crude oil. Short of a major new production announcement I don't see that as happening. First of all OPEC members are not going to divulge any classified data and all their reserves and production data is classified. Unless that is suddenly going to change this is likely going to turn into a Saudi lecture and panel discussion and prices will be free to rise again on Monday once traders decide there is not a million barrels per day suddenly going to appear out of OPEC.

Saudi also said they were going to double their international refining capacity by 2012 to 6 mbpd. Again, old news. Their last two announced refinery projects have yet to be started. Announcements are cheap and refineries are expensive.

Attending the meeting are 35 government officials like Samuel Bodman, U.S. Energy Secretary. Also 25 executives from major oil companies, officials from OPEC, the IEA, EU and the IMF. Even Venezuela did an about face on Friday and said they would attend. They were initially boycotting the meeting as unnecessary and claiming oil prices were still too low.

Other big news was the report in the New York Times on Friday that Israel had staged a maneuver over the Mediterranean and Greece that had all the appearances of preparations for an attack on Iran's nuclear facilities. The mock raid involved more than 100 Israeli F-15 and F-16 warplanes along with aerial refueling tankers, helicopters for pilot rescue, radar planes, etc. The warplanes flew more than 1400 kilometers, about the distance from Israel to Iran's nuclear enrichment facility in Natanz. This major exercise was obviously designed to demonstrate their capability of striking Iran as they have promised if Iran continues uranium enrichment. The U.S. confirmed the maneuvers and the potential of an attack on Iran. This was clearly designed to send a message to Iran and to the world that Israel was not making idle threats to end Iran's nuclear project. Israel destroyed Iraq's reactor facility in 1981 and a nuclear site in Syria several months ago.

Shell declared force majeure on 225,000 bpd of June and July production from Nigeria after the rebel attack on Thursday. That is a huge amount of light crude off the market for the next six weeks. A Chevron pumping station in Nigeria was attacked on Thursday night but there was no word on production declines. Chevron was also in the news as talks with workers in Nigeria fell apart and a strike is expected. A strike would impact Chevron's daily output of 350,000 bpd in Nigeria.

Transocean (RIG) said it won a contract extension for the semisubmersible vessel GSF Development Driller II and the extension would begin in November. The contract would produce $1.6 billion in revenue for that one ship. It is only 1 of 35 highly specific drill ships Transocean operates. Eighteen are able to drill in 7500 ft of water or more. They are truly minting money but the stock has been dormant after the GSF merger. We were stopped out of a RIG play several weeks ago. It may be time to roll the dice again.

I added three stocks to the watch list that are heavily invested in the Haynesville Shale formation in Louisiana. This is a new play in old fields. The shale is below 10,000 feet and most of the oil deposits were found much higher many years ago. With the new technology for horizontal drilling in shale this is the hot new/old discovery. As I mentioned in the lead commentary for GDP in the watch list CHK paid $178 million to Goodrich for a 50% working interest in some Haynesville Shale acreage. As I read further CHK said the Haynesville Shale could end up being the biggest asset they own and produce more gas than any other CHK property. That is a huge statement given CHK's massive footprint in places like the Barnett Shale in the DFW area. Encana (ECA) is the largest gas producer in North America and they said the Haynesville Shale could be the biggest gas field in North America. Since the play is very new most people have never heard of it. As the news gets out I believe these three gas plays will explode. There have only been 30 units formed to date in the Haynesville because it is so new. A unit is 640 acres (1 square mile). That means only 30 square miles have been plotted for drilling but the play itself is huge. Reportedly landmen are going door to door trying to acquire acreage for lease. They are making announcements at church services and holding neighborhood meetings wherever possible. The city of Shreveport took a trip to the Dallas/Fort Worth area to see how the massive influx of drilling rigs was being handled as the Barnett Shale is being developed. They are drawing up plans for drilling on public parks, roadsides, etc. It is a land rush or maybe I should say gas rush all over again. The Barnett shale covers 16-21 counties in Texas and the Haynesville Shale is said to be larger than the Barnett. The discovery was just announced in March.

Don't forget the Association for the Study of Peak Oil (ASPO) is holding their annual conference in Sacramento on Sept 21-23rd. This is a full 2.5 days of intensive, as in 8:AM to 9:PM information overload from dozens of experts from around the world on the status of Peak Oil. The cost is minimal at $325 because they are a non-profit and make no money on the event. Follow the link below to register and join me there. We can discuss each presentation and plan trades for the coming year. Put my name in the "how did you hear" box so they can group us together for the meetings. Go here to register:

Jim Brown

August Crude Futures Chart - Daily

July Natural Gas Futures Chart - Daily

July Gasoline Futures Chart - RBOB Daily


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