Option Investor

Twilight Zone

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Ladies and gentlemen you have entered a place where normal laws of supply and demand no longer apply. A place where hurricanes can cripple three weeks of crude production in the gulf and shutdown over 20% of U.S. refining capacity without any rise in crude prices. This is a place where gasoline inventories are at 8-year lows and crude supplies could drop by more than 20 million barrels next week and yet oil prices dropped below $100 on Friday. You have entered the Twilight Zone.

I may not be Rod but this is definitely the Twilight Zone. Crude prices actually fell on Friday while Texas Governor Rick Perry was predicting $100 billion in damages on refinery row in Houston. "If we get the 20 foot storm surge we are expecting it could take 1-3 months before all the refineries are operating again. There are 13 refineries in the Houston area representing over four million barrels of refining capacity and all were shutdown well before hurricane Ike made landfall Friday night.

Ike was a monster 600-mile wide storm with an almost unheard of eye of 49 miles across. It came ashore Friday night with winds of 110 mph, only 1 mph below category 3 levels. The storm was so large experts said it could take 12 hours to pass over Houston.

The reason the price of oil was not rising is actually a refinery problem. Refinery utilization last week was only 78% because of the shutdown for Gustav. This week over 20% of U.S. refinery capacity was shutdown before Thursday to prepare for Ike. If Ike really did knock out all those refineries in Houston there would immediately be a surplus of crude even with production in the gulf shutdown. No refiners, no refined products and no consumption of crude. Gasoline, heating oil and jet fuel will rise as supplies dwindle but crude prices should sink. The U.S. only has 20 days of supply in gasoline and that includes the gasoline in the pipelines that cannot be removed. The only reason crude prices should rise next week is severe damage to the offshore wells and production platforms. Since Ike moved through the oil patch as a category 2 storm most should have survived intact.

Saturday Update: I wrote the above on Friday night and as of late Saturday afternoon it appears the damage was far less severe than expected. Refineries are already restarting and oil companies are sending the first wave of workers back to the production platforms in the gulf. There will probably be some lingering refinery problems until power is restored but I could not find any news updates about major damage to any oil facility.

Refiners on the west coast stand to benefit because they won't be harmed and can run at 100% capacity to meet the shortfall. Holly (HOC) and Tesoro (TSO) are prime examples. Of course the bounce will be short lived. Valero got a bounce because of its wide footprint only three of its refineries were in harms way.

Shut In Production In the Gulf

Despite flooding in Louisiana and several levees being topped by the surge the Louisiana Offshore Oil Port or LOOP should be back in operation quickly. Companies should begin damage assessment and restart of production platforms in the gulf by late Sunday. There are no other storms on the horizon to cause problems. Tropical storm Josephine dissipated last week and the remnants are generating rain a couple hundred miles northeast of the Bahamas.

The Minerals Management Service said personnel had been evacuated from 453 production facilities, or 63% of the 717 manned platforms in the gulf. 81 rigs were evacuated or roughly 67% of all gulf rigs. Shell reported that its Perdido spar escaped the wrath of Ike even though it was a direct hit in the deepwater gulf.

Hugo Chavez is stirring up trouble again. A day after two Russian Backfire bombers landed in Venezuela Chavez expelled the U.S. ambassador and threatened to halt exports to the U.S. in a show of support with Bolivia. Bolivia expelled its top U.S. envoy two days earlier and accused the U.S. of backing opposition in Bolivia. Chavez needs the U.S. and Venezuela is the 4th largest supplier of oil to America. If we cut him off he would dry up and blow away. He is never going to cut us off or he would be out of money inside a week. His threats are used to get sympathy and support from his people and to raise oil prices. According to the IEA his production is running 150,000 bpd under his quota. He is taking all the cash flow from the oil industry and not leaving them enough to increase production. As one analyst put it, "He is taking the cows milk but not feeding it enough hay to survive." Let's hope he drowns on that milk.

It is that time of the month again. The October crude futures cease trading on Monday 9/22. You can expect that to add to the volatility next week. I am expecting the price of oil to fall next week simply because every event including a cut by OPEC has been ignored. You may remember the monster dive of -$8 the futures took on the Monday after Gustav. There still seems to be more sellers than buyers and those waiting to sell on hopes crude would spike on massive damage may be disappointed and exit quickly ahead of expiration.

Jim Brown

If you have registered for the ASPO Peak Oil conference and have not received a personal email from me with conference notes please send me an email. There is still time to register and join the crowd. Go here to register: http://www.aspo-usa.org/aspousa4/

October Crude Futures Chart - Daily

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October Gasoline Futures Chart - RBOB Daily


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