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LEAPS Trader Update - Thursday 9/14/06

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LEAP Trader Update - Thursday 9/14/06


I received an email from a reader today that I thought would be beneficial for everyone.

Dear Jim,


I have a question about this newsletter, which I am forwarding to you.  I believe that this newsletter writer has been much more knowledgeable than most analysts or newsletter writers about energy stocks.  He has taken much the same attitude that you have about the issue.  However, he is advocating taking a turn away from energy with some comments he makes in favor of real growth technology stocks.  He says there is still money to be made in energy.  However, he feels that there is more growth potential in other areas.  And, he says that no one area leads the market for four years in a row, so they are taking profits on the energy stocks which have led for three years.  I am also wondering about some recent news stories about discoveries of new oil reserves.  If you could take a few minutes to let me know your reaction to all of this in regards to your leaps recommendations for energy stocks, I would appreciate it.


Thanks J.

Those are some good questions. Oil supplies are plentiful right now due mostly to the warmest winter on record and the lack of any hurricanes forcing a shutdown of rigs in the Gulf. Assuming we have a normal winter those supplies will decrease along normal cyclical patterns. This will result in a tighter supplies again in the spring and summer of 2007.

Much of the support under oil prices has not been a shortage of oil in 2006 but rather a surplus of geopolitical concerns. Iran, Iraq, Lebanon, Syria, Nigeria, Venezuela, Ecuador, Bolivia, etc. With most of those moving to the back burner as summer ended there was no specific reason to continue buying oil ahead of a potential cut in production in those areas. Iran will move back into focus but it could be months. They have become masters at the delaying game. The end of summer also marks the end of gasoline demand and the demand for natural gas to generate electricity for cooling. This combination of events coupled with oil and gas inventories at multiyear highs provided a perfect excuse to take profits. 

Long term there is no hope for cheap oil. It is simply a matter of math. According to Chevron we are using 3 bbls for every one bbl found for the last 20 years. All but 2 OPEC countries are already in permanent production decline. The current depletion rate in the industry is being quoted at -8% per year by major companies in the industry, not outside spectators. That means a mature field is losing -8% of its production per year and that is a geological fact of life that cannot be disputed or reversed.

Assuming that the rate is only 50% of that 8% still provides us with a serious math problem. Using only a -4% depletion rate on the current 83,000,000 bbls of production every day that means oil companies must find and produce 3.32 million bbls of new oil EVERY year just to maintain current production levels. While there have been new discoveries the rate of discovery is far below the rate needed to replace those 3.32 million bbls per day. Furthermore it takes from 4-7 years to produce oil in any quantity from a new field. Oil found today will not appear on the markets until 2011 at the earliest and 2014 in any quantity. That is 7 years into the future and it will require nearly 25 mbpd of new daily production just to offset the current depletion rate over that period. The new BP discovery was estimated to add 500,000 bpd by 2014. That is a far cry from the 25,000,000 bpd needed to keep production level while we wait for 2014 to arrive.

On the demand side automakers sell around 17 million new cars in the US each year. Only 2 million are crushed for a net gain of 15 million cars per year. Adding in sales around the world and that 15 million cars more than doubles. Those cars burn a lot of gasoline and will add appreciably to demand between now and 2014. China and India are growing rapidly and oil consumption is jumping at the rate of +10% or more per year from those countries. Together they have 2.4 billion people all trying to move into the 21st century. Each person in China consumes only 1.5 bbls of oil per year and 1.0 bbl for India. This compares to 22 bbls for every person in America and the mid teens for most other developed countries. Increased demand from India and China alone will continue to add +500,000 bpd per year to demand each year for the next 20+ years as their infrastructure is expanded and population moves from horses and bicycles to cars. China is currently adding 500,000 cars per month when they had less than 50,000 cars total in the 1980s.

Newsletters like the one you sent me have to keep readers constantly involved with changing positions. A newsletter, which constantly advertises to the public with spam and snail mail has to constantly have some new and sexy angle to hype in order to get and retain new readers. I am not saying that was not a decent newsletter but their overhead is easily 100 times more than ours and they need to constantly add to the subscriber base to stay afloat. By constantly advertising some new change in the market with pages of snappy advertising hooks it keeps them in business.

Tech stocks are hot right now and they may be hot for the next several months. However, if the economy really is slowing this rally will eventually stall just like every other rally in every other sector including energy. All sectors are cyclical. My view in keeping the LEAPS newsletter focused mainly on energy is to keep our eye on the ball. This will be the greatest growth sector for the next several decades and by watching the cycles closely we can be astute buyers on corrective dips like we have now. It is not necessary to be 100% invested all the time. It is better to be ready for the next buying opportunity and profit extremely well when that opportunity appears.

I hope this helped understand my outlook and perspective.

Thursday market action

Today's market action saw oil prices decline to $63 and a new 8-month low. Much of the decline today was related to expiration activity in the October contract and the implosion in natural gas. Gas inventories saw an injection of 108 bcf into storage. This was a huge amount and reflected the end of summer and cooler temperatures. This brought the amount of gas in storage to 3,084 bcf and extremely close to the maximum storage levels thought to be in the 3.2-3.5 tcf range. One more week of large injections and gas in the pipeline could begin to backup as pressures increase and storage locations quit accepting additional gas. The price for the October contract fell to $4.87 and a low for that contract dating back to Jan-2004.

I warned everyone over the last couple months that oil prices would fall towards the end of August and early September. The drop was right on schedule. I warned everyone that gas prices would collapse as inventory levels rose. So far that is right on schedule. I am waiting for the bottom to form before adding those gas stocks I spoke of last week. No rush here.

So far there have been no surprises in the energy sector. Everything has been going according to plan. We have not conjured up some new advertising scenario to capitalize on the correction appearing as expected nor have I decided to spread out into other sectors like Housing, Healthcare or Technology to keep the newsletter interesting. We have a game plan and we are going to follow that plan. We added several new long term positions this week and if the correction continues to $60 we will add some more. Then we will sit back and wait for the eventual rebound. It will come. Maybe not next month or maybe not this year but it will come. $100 oil is a guaranteed event as is $5 gasoline. We will profit from those trends when they arrive. If you have any questions feel free to email me at jim@optioninvestor.com and I will try to answer them in person and in the newsletter. I don't claim to have all the answers but I can find them. I am currently working on a book about investing for Peak Oil so I am awash in an abundance of facts.


Jim Brown

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