Option Investor
Commentary

Women and Children First

HAVING TROUBLE PRINTING?
Printer friendly version

This is about the point in those old movies where the captain of the sinking ship lowers the lifeboats and says women and children first. The men, brave or not, get to stay behind and try to keep the ship from sinking or at least drown while secure in the knowledge their wife and kids were safe.

I have a different view this week. There has got to be a bottom somewhere close because we have been stopped out of 12 positions in the last two weeks. We only have seven left and the biggest rebound of the year will occur as soon as we go flat and step aside to watch. It always happens that way. After getting a bloody nose two weeks in a row the average investor recoils to the shadows to lick his wounds only to see monster rebounds while he is out of the market.

However, I do not want to be that investor that looks back several years from now and tells his grandkids that "I driven out of the energy market in the crash of 2008. That was the biggest drop in oil prices in history! Yes siree Bob, that one busted me and the next year oil went to $300 a barrel!"

Emotionally I want to buy because nothing goes straight down and $147 to $123 is pretty dang straight. With $122 strong support this would be the perfect place for a rebound. With storms heading for the Gulf, violence spiking in Nigeria, production falling in Russia and Mexico and a failed attempt to pass a law against speculation this "should" be a great place for a rebound. Should and could always get me in trouble. Whether I "should" have waited or I "should" have jumped in, there is always risk. On one side there is the risk of lost capital if you jump in. On the other there is the risk of lost opportunity if you stay out. Given the choice in hindsight we would always choose lost opportunity over lost capital.

For that reason I am going to be sparing on adding any more current plays this weekend but I am going to add a lot to the watch list. The current levels on many of these energy stocks are very compelling and we will be kicking ourselves if we pass up any future dips. The commodity markets are going down in flames and they don't appear to be linked to any common cause. The fertilizer companies are dropping like somebody found a miracle nutrient that doubled production overnight without potash. In reality every company repeats almost weekly that demand is much higher than supply. Products are being rationed and prices are rising monthly. That appears to be lost on investors with POT down $30 in two weeks and Mosaic down $24.

With the markets in a state of disarray and the two worst months of the year August and September maybe it is time to pull in our horns and be timid in our entries. Of course that would be a sure sign of capitulation and that is something you want to watch others do for a sign to jump in.

There is no easy answer. Nothing has changed fundamentally other than $4 gasoline has knocked off about one million barrels per day of demand. That still puts us on track to need another 600,000 bpd or so in 2008 and another 1.5 mbpd in 2009.

Trading is cyclical and this cycle may have run its course. Next week will be the key. There are no expirations and oil closed right at support on Friday. If it breaks here the next stop could be $110 and I would rather not ride longs to that level. I am going to keep the stops tight but try to keep at least a few positions open to catch a rebound when it occurs.

I am not going to spend a lot of time in each play description explaining why we got stopped out. Repeat after me, "It was the largest dollar drop in the history of the oil market." The 12th largest energy-trading firm in the nation with professional traders and billions in capital failed last week with a $3.2 billion loss on their positions. That does not make our loss any less painful but we are in good company.

Jim Brown


Readers Write:

You have made the point several times that the problem with the oil crunch is a transportation issue. It is not a power grid issue (coal, nat gas and nuclear). I invest in nat gas stocks and continually come across the upbeat phrase that oil trades at 13:1 to nat gas and it has only been 6:1 historically. Therefore, nat gas will soon double in price. Am I correct to be scratching my head? Oil is principally international (therefore risky), is running out and its use in transportation cannot be substituted today. Nat gas is a power grid driver and there have been some recent large finds giving hope to the future. It faces a different, but tight, demand curve. Heating days, cooling days, hurricanes, Google server farms and political backlash against coal and nuclear drive nat gas I would think.

What am I missing?

I am not sure you are missing anything. These two fuels get intermixed daily by the media but as you pointed out they are not the same. Boone Pickens is trying to get the U.S. to convert to nat gas for transportation but that is not the answer. Nat gas fueled vehicles typically get only 200 miles per tank and nat gas is not really that less expensive (today). The relationship between oil and gas pricing is going to diverge further as oil becomes harder to get. However, nat gas production peaked in North America in 2004 so that fuel is eventually going much higher as well.

The problem with gas is the huge demand for a power generation fuel. More plants are under construction in North America and yet our supplies are already declining. LNG was supposed to be the answer four years ago when middle east gas and gas from Russia was $1 per MCF. Now that gas is going to Europe, Asia and India where they are willing to pay more than the U.S. is paying. It is only going to get worse. There is plenty of gas in the world but transporting it to the place of use is a challenge. It can be consumed much faster than it can be transported. The demand for clean fuel is overpowering the nat gas system.

You are right that nat gas will double but not because it is tied historically to 6:1 oil. It is going to double because we are already running out of it in North America. Estimates I have heard among the gas producers are $20 mcf in 2010 and $25 by 2012. The problem is simply rapidly expanding demand, as in new gas fired electricity plants, new manufacturing plants, new homes and now new vehicles. Supply is declining despite the drilling in places like the Barnett Shale, Jonah Field, Haynesville Shale. These gas wells come on very strong the first year then drop off sharply, some as much as 85% for the duration of the well. In order to keep production high they have to keep punching new wells as fast as possible to get than initial first year pop. Unfortunately they can't continue to drill faster and faster simply because there are not enough deposits or rigs. We are drilling three times as many gas wells per year today as we were 10 years ago but production is declining.

Yes, gas is going to double.

Jim

(I am going to try and make this a weekly feature. Send me your email questions and I will try to answer. Jim @ OptionInvestor.com)


September Crude Futures Chart - Daily

August Natural Gas Futures Chart - Daily

August Gasoline Futures Chart - RBOB Daily

 

Leaps Trader Commentary Archives