Option Investor

Discouraging Reversal

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On Thursday crude oil rallied on a major commodity short squeeze to $122. On Friday that move was completely erased with a -$6.59 drop. The reason for the spike was supposedly the failure of the Russians to leave Georgia. That may have started the short covering but in any move of that magnitude it was the squeeze that supplied the lift. On Friday Russia completed its pull back out of Georgia and the dollar index saw a massive 61-cent spike. Both added fuel to the selling in commodities and especially oil. We saw oil go from $111.50 to $122 in just a couple days and then reverse to close at $114.59 on Friday. Volatility is still with us.

Fortunately for us the portfolio survived the week without a scratch. The stocks in the energy sector faired better than the crude contract despite giving back some ground on Friday. Unfortunately we did not add any plays either because of the rise in several stocks we were looking to buy on the dip.

You may have seen the email I sent out on Wednesday with the monster 9.4 million barrel jump in crude inventories. This was purely a catch up week for all those tankers who were in a parking orbit waiting for Eduardo to go away. You would have expected prices to drop sharply as the uneducated traders dumped positions thinking something had changed fundamentally in the oil story. With Fay running around in the gulf for the last two weeks we are liable to see the same drop in imports two weeks from now as the numbers show tankers waiting for the storm to blow over and then a spike in three weeks as the numbers catch up.

As I reported in the Option Investor commentary this weekend Fay has done the impossible. She crossed Florida from west to east, spent a day on the ocean side and then reversed course to move back into the gulf late Friday. She has drawn a bead on New Orleans and appears on a direct course to impact on Sunday. Currently the wind chart only has the outer bands stirring up trouble for the oil rigs close to shore but should she strengthen those bands would widen. There is also another storm not yet developed into the naming stage that is heading up hurricane alley between Cuba and Mexico. If that one turns into a hurricane it could be a direct hit. It should be off the coast of Venezuela by Saturday night and we should know if it is going to turn into a storm by then.

I am not going to spend a lot of time on commentary this week. I would like to invite everyone to attend the 2008 Peak Oil Conference with me on Sept 21-23 in Sacramento. About 20 Option Investor subscribers and myself will be attending and it will definitely be fun and entertaining. There are dozens of speakers and all the presentations will have reams of data on Peak Oil and its impact. It is not specifically on investing for Peak Oil although there is a presentation on that in the schedule.

The conference will convince anyone that peak oil is real and give you a countdown calendar for its arrival. I have dozens of people email me every week asking questions about peak oil. This is where to get your answers. The first day is the story and all aspects of the coming problem will be presented. The second day covers the impact. What role will coal play? What is the future for aviation? How will governments react to the changes? What hardships will ordinary people be forced to endure?

I have been to two of these ASPO conferences and it is the only conference I would not miss for the world. This is the definitive answer to all your peak oil questions.

All the Option Investor attendees will sit together so we can talk about the presentations during the breaks. I will be holding an evening session just for OI attendees and it will be Q&A and a general discussion about what we heard that day and how to profit from it. I strongly suggest anyone concerned about their future not miss this opportunity.

Go here to register: http://www.aspo-usa.org/aspousa4/

On the third page of the registration put my name in the "How did you hear" box. That way I can track the registrations and send you emails about meeting times and places.

I guarantee you will not be disappointed with what you learn.

See you in Sacramento!

Jim Brown

Readers write:

Jim - I have been a subscriber for several years and have come to value your opinion highly. Could you address these types of comments that have been coming out lately? Isn't Sept/Oct usually a time for higher oil--hard to imagine prices are going too much farther with the supply/demand issues and tensions in the world? So you think it will takes months to bottom? What are your thoughts? JK

Good question JK. I didn't include the comments from another analyst JK included suggesting oil corrections take an average of 1.2 years since we are not in normal times. I have been saying for many months that we don't really have a shortage of generic oil (all grades) just a shortage of light sweet crude that everybody wants. But even that is not really the problem.

The problem over the last six months is one of perception. Everybody thought there was a shortage because Goldman and others were coming out with their super spike theories. It is tough to believe there is plenty of oil when all the major brokers are calling for $150 to $175 oil before the year is out. I believe this developed into a self-feeding rally. Hedge funds jumped on board and kept increasing the size of their bets and I am sure a few sovereign funds from oil producing countries helped to juice the futures whenever they started to weaken.

Eventually Saudi Arabia called their bluff as they have in the past by shipping more oil than they were allowed by quota in order to take the psychological edge out of the market. Their conference helped to calm the fever and then the weight of the long positions in oil did the rest.

Oil did decline over 20% making it a technical bear market but I don't think anyone would have believed in January that we would be calling $120 oil in July a bear market. $120 oil is still expensive oil. Now that supply and demand speculation has been removed from the market we are going back to a supply/demand model at a higher price point.

OPEC will probably make an announcement they are going to enforce quotas at the Sept-9th meeting. That means Saudi will be "forced" to back off their current production but they only said they would do it for two months when they started so it is only a sound bite not a real change in policy.

The real change in OPEC's position will be when Saudi brings on the 1.2 million barrels of daily production early next year. That is in addition to their 500,000 bpd of new production scheduled for Q4 2007. This will provide a significant level of excess production and it should be reflected in oil prices even if they never open the spigots.

I posted a summary of new oil projects coming online over the next five years about a month ago in this column. You can check your back newsletter copies for the details.

Bottom line is 2009 will be a banner year for new oil production coming online. It will be the last big year according to the calendar we have today. This will keep prices from returning to the $147 level for probably the next 24 months. However, as I said earlier $120 oil or even $100 oil is very profitable oil for 99% of the energy companies. In Feb-2007 when Oil was under $60 any oil company would have never dreamed it would double in price over the next year and still be called a bear market.

I agree there are supply/demand tensions in the world. Nigeria may not return to full production of light crude for a couple years. However, we do have lots of light crude coming online from other fields over the next 18 months. Maybe not 1.5 mbpd but plenty to offset the current Nigerian shortfall.

Our biggest problem today is going to be the demand destruction we are seeing in the U.S. with demand -4% below 2007 levels. Now that prices are back in the $3.75 range SUV sales have already picked up. This is probably a knee jerk reaction and won't hold up unless prices continue to fall. Most Americans have not bought into the peak oil story yet.

So to answer your question, I do NOT believe we are in a bear market for oil. The comments you sent me from the other newsletter are not valid. That company is a serious ad spammer. They have to invent a new problem or a new discovery every month to make their next newsletter ad more enticing than the last. I subscribe to dozens of newsletters including that one and I continually laugh at the lengths they go to in selling subscriptions.

I believe oil prices will remain over $100 despite the new production because OPEC will want them to remain over $100. Also, the continued increase in demand for light crude will keep that market in tight supply. Remember to ignore OPEC comments about "market well supplied" because they are using all grades in their calculations even the ones nobody wants.

We will continue to buy the dips in oil service companies and drillers and anybody else that looks interesting. I do not expect these companies to go straight up until next years production is consumed by rising demand. Until then we will experiment with some solar plays, wind and natural gas. There are unlimited opportunities if we don't get impatient on our entries. We are entering a period where the sector will be choppy but profits will remain strong.

Jim Brown

(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)

October Crude Futures Chart - Daily

September Natural Gas Futures Chart - Daily

September Gasoline Futures Chart - RBOB Daily


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