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Weekly Newsletter, Saturday, 06/18/2005

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Table of Contents

  1. Commentary
  2. Changes in Portfolio
  3. Portfolio Listing
  4. New Plays
  5. Existing Plays
  6. Watch List

Leaps Trader Commentary

Bad News Continues to Push Oil Higher 

Nobody invested in the current LEAP portfolio should be complaining about those higher prices. July crude futures surged to close at $58.50 on Friday and the December contract soared to close at $60.40 and a new all time high. 

OPEC announced after its Wednesday meeting that it was going to raise its production ceiling to 28 mbpd but the news fell on deaf ears. The ten OPEC members the ceiling is supposed to impact are already pumping more than 28 mbpd and prices are still rising. 

I have reported on the real problem before but it is now beginning to make the headlines in the mainstream press. The problem is that all additional production capacity is in heavy sour crude and a product that can only be used by a small number of refineries in the U.S. When you refine (crack) heavy crude you end up with more than 50% heating oil and less than 15% in gasoline and naphtha. This is far less gasoline than is produced from a barrel of light sweet crude. This means you have to refine more heavy oil than light oil to produce the same amount of gasoline. Half the U.S. demand for oil products is gasoline and naphtha, far more than the heavy crude refiners can produce. Heavy crude currently sells for about $10 less per bbl and that is a windfall for those refiners like Valero that can refine the heavy oil. 

Several comments from OPEC members last week helped cause a ripple in prices. The Libyan oil minister publicly said what many of us have been saying for the last year. He said all excess production over 28mbpd would be heavy crude. This may not seem like an overly bright statement for anyone reading my articles over the last year but it was the first time anybody in OPEC had actually confirmed it. This was a shock for anyone still living by the often repeated "oceans of oil" comments. Yes, there are oceans of oil but that ocean is so thick you could nearly walk on it without sinking. This caused one round of price hikes on Thursday. 

There was also a new series of articles, some in the Arab papers as well, that Saudi production had peaked due to major damage in their biggest fields. When oil is pumped out too fast it can cause problems underground including collapsing of the field. Saudi has been pumping at nearly 100% for the last two years in an effort to keep up their oceans of oil image. Like I said earlier this week, there are cracks in that image that will likely become larger and westerners will eventually see the real story as the news leaks out. 

Another problem for oil last week was a sharp drop in oil inventories. Talk is cheap but it does not change reality. Some analysts continue to claim that there is plenty of oil in the system and there is no shortage. Unexpected drops in inventory levels weakens that contention. Eventually all analysts relying on the oceans of oil claims will find themselves paying $3 or more for gas just like the rest of us. However, readers of this LEAPS column will be cushioned from that blow from solid profits. 

The LEAP portfolio is now officially an energy only portfolio. The DJX put suggestion from last week was stopped out on Friday for a minor 45 cents loss. The rising interest rates rescued FNM from a break of the $58 support and I dropped it this weekend. This leaves only energy stocks in the portfolio and I plan on leaving it that way for the rest of the year. We will concentrate on trading/investing in the energy sector until the peak in prices sometime this fall. I do expect a pullback after last week's gains and we will use any pullback to enter new positions. 


Changes in Portfolio

New Plays

None


Dropped Plays
DJX
$106.27 Dow Puts ** Stopped $106.25 **
FNM $60.13 Fannie Mae ** Dropped $60.13 **

New Watch List Plays Triggered

None


Portfolio Listing & Top Picks


New Plays

Most Recent Plays

None today.


Play Updates

Existing Plays

DJX - $106.27 Dow Puts ** Stopped @ $106.50 **

Fortunately our good entry limited the risk and although we were stopped by Friday's surprise bounce the loss was limited to -45 cents. The market was looking weak last Sunday but that weakness has completely disappeared. 

I suggested this play because I thought Greenspan would confirm that Fisher spoke out of turn and the Fed was still on its measured pace program until Q4. I also expected Intel to fail to impress. Both events came to pass but the market did not implode as I expected. 


Aug $104 PUT DJV-TZ @ $1.55, exit $1.10 (6/17)

No insurance call - Stop at $106.50

Entry $105.50 (6/7)

CHK - $23.36 Chesapeake Energy ** Stop $20.50 **

CHK surged to within 50 cents of a new high and is showing no indications of any weakness. The July put insurance is now worthless after the strong gains and I have instituted a stop at $20.50 instead. This is below the prior support and the 100-day average. 

Company Info

Chesapeake Energy derives 90% of its revenues from natural gas. They are very aggressive about replacing reserves and will capitalize on the continued increase in prices. Gas prices have soared in the U.S. due to the addition and conversion of electric plants to the cleaner fuel. Several times over the last winter the gas levels supplying those plants dipped to dangerous levels. The demand is increasing faster than supply and the production peak is now estimated to be 2007. Prices are going to continue higher, much higher and Chesapeake is positioned to benefit. 

This summer much of northern California will get its electricity from gas due to a drought in the northwestern hydro-electric grid. Generation levels will be below normal and natural gas is the fall back fuel. 

2007 $20 LEAP Call VEC-AD @ $4.00

Insurance put: July $17.50 CHK-SW @ 90 cents

Entry $19.00 (05/13)

FNM - $60.13 Fannie Mae ** Dropped ** 

FNM appeared to be ready to crack last week with a drop to support at 58 and no signs of strength as long as interest rates were dropping. The +28% surge in mortgage applications and the jump in interest rates nearly stopped us out and the trend is now positive. I am dropping FNM today as it looks like sentiment has changed. I have heard nothing about the regulator probe in several weeks. 

Company Info

Stronger jobs would mean more home loans for FNM but also higher rates from the Fed. That is not the problem we fear. Regulators are increasing their attack on the entity and Greenspan reiterated his warning on May-5th. He wants Congress to limit the multibillion-dollar holdings of FNM/FRE and warned again that any major problem with either could severely damage the U.S. markets. He favors allowing them to only hold the minimum level of mortgages as required by their charter. This would be a drastic cutback from current levels. 

Fannie Mae has been suffering from numerous ailments including accounting problems. The regulator for FNM has asked for more power to dig deeper. We suspect any deeper digging could turn up some more skeletons. 

2007 $50 LEAP Put VFN-MJ @ $5.40, exit 3.10, -2.30

Insurance Call 
June $55 FNM-FK @ $2.00, exit 6/06 $3.60 

Entry $55 (5/04)

APC - $82.52 Anadarko Petroleum ** Stop $74.00 **

APC broke out to a new high on Friday well above the $80 resistance. The June insurance put expired worthless for a loss of 85 cents but the LEAP is now up +$6 so no harm there. I instituted a stop loss at $74 in lieu of the expired put. This is under the last major support. 

Company Info

Anadarko has 2.37 billion barrels of proven reserves. They are the largest independent in a field of giants. Buying reserves is cheaper than finding them. 

Anadarko has just completed a restructuring program and raised estimates on May-2nd. They expect output to rise +5% in 2005 and costs to be below industry trends. S&P is estimating $8.55 for earnings in 2005 and a price target of $85. 

2007 $75 LEAP Call OCP-AO @ $10.10

Insurance Put 
June $65 APC-RM @ $0.85, expired worthless 

Entry $70.50 (5/04)

COP - $60.67 Conoco Phillips ** Stop $52.00 **

COP was by far the best performer for the week with a strong surge over prior resistance at $56.50 and a multi-day breakout to new all time highs. The June insurance puts expired worthless but the leaps are now up +$6.62 over our entry. Since COP split 2:1 at the beginning of June that translates into a +$13.24 gain over the original contract price. With the put now expired I put a stop on COP at $52. 

Company Info

COP reported earnings of $4.10 that rose +80% over the year-ago period. Analysts had only expected $3.29. They said unplanned down time at refineries kept them from doing even better. They also said they were going to spend $3 billion between 2006-2010 to increase their ability to handle the cheaper sour crude. 

COP has been aggressively purchasing assets around the globe and especially in Russia. Putin has said repeatedly that COP assets and agreements are not at risk and that COP is a partner with Russia in producing their oil. 

2:1 Split on June 2nd gave us 2 of each. 

(2) 2007 $50 LEAP Call OJP-AJ @ $7.88

Insurance put:
(2) June $50 COP-RJ @ $1.08, expired worthless

Entry (4/18 $49.00)

OXY - $80.05 Occidental Petroleum ** Stop $73.00 **

OXY broke out to a new high once again and is more than +$12 over our entry point. The June put expired worthless and I have placed a stop at $73 just under early June support. 

Company Info

OXY declared a quarterly dividend of 31 cents in early May and appointed former U.S. Secretary of Energy, Spencer Abraham, to their board. Earnings in 2004 were a record $2.6B and as the CEO pointed out on Friday it was more than a billion more than they earned in 2000. Not a bad growth record. Q1 earnings were up +74% over Q1-2004. 

OXY reported earnings on April 26th of $2.16 per share compared to estimates of $1.99. OXY said it had higher than expected production, strong pricing and record chemical sales. Still it failed to produce the blowout earnings of COP due to hedging. 

OXY reported an agreement with Oman to invest $2B in the Mukhaizna oil field and upgrade production from 10,000 bbls per day to 150,000 per day. I would happily invest $2B once to get $3B return per year. Good job!

OXY is the 239th largest company in the world and an oil giant. 
Occidental's principal activities are to explore for, develop, produce and market crude oil and natural gas. The operations are carried out through two segments: Oil and Gas and Chemical. The Oil and Gas segment develops, explores for, produces and markets crude oil and natural gas. The Chemical segment manufactures and markets basic chemicals. The company operates primarily in the United States, Qatar, Yemen, Colombia, Oman, Pakistan, Canada, Russia, Ecuador and the United Arab Emirates.

2007 $70 LEAP Call VXY-AN @ $10.00

Insurance Put: 
June $65.00 OXY-RM @ $1.40

Entry $68.00 (4/19)

XOM - $60.89 Exxon Mobil ** No Stop ** 

XOM is beginning to pickup speed and broke above its first line of resistance at $60 on Friday. The July $55 put is nearly worthless but still within range only $5 below. No stop on XOM yet. 

Company Info

XOM reported a +44% jump in earnings but missed analyst estimates. After items XOM earned $1.15 and analysts were expecting $1.20. XOM hedged to capture high oil prices and prices continued to move higher. They also saw a drop in production as mature fields continued to decline. XOM said it will spend $15-$16 billion in capex in 2005 in an effort to discover/produce more oil. They also said they were going to buy back $3.5 billion in stock in the current quarter. Their record profits of $7.86 billion for the quarter give them plenty of cash for anything they desire. Maybe a couple acquisitions would help that sagging production. 

XOM has larger reserves and more cash than any other oil company. They have to find something to do with their $30 billion and it will either be returned to the shareholders or used to buy more reserves. 

XOM is the largest oil company in the world and while it has the largest reserves it also has the highest overhead cost. 

2007 $60 LEAP Call ODU-AL @ $6.70 

Insurance Put:
July $55 Put XOM-SK @ $1.20

Entry $58.00 (4/19)

XLE - $45.84 Energy SPDR ** Stop $41.50 **

The XLE has really picked up speed along with the majors oils. The XLE broke out to a new high over resistance at $45 and with the put now expired I have instituted a stop at $41.50. The XLE should continue to perform well as those left out of the current rally try to hedge their bets by buying the SPDR instead of speculating on individual stocks. 

Company Info

The XLE SPDR is composed of 27 energy stocks and represents about 8% of the SPX. This is the 8% that helped push the SPX to the current levels with the rise in oil over the last year. In fact the XLE has far exceeded the SPX in performance over the past year.

The XLE functions like an energy index and should rebound or bottom before oil stocks in general. Once traders start nibbling at the individual stocks in the index we will get our first glimpse of a rebound in the making. 

I chose a leap close to the money because there was no material price difference for the Leaps $2-3 away. Insurance is cheap and I expect this to be a very long-term play. 

BUY 2007 $40 LEAP Call ORJ-AN @ $5.60

Insurance put:
Buy June $39 Put XLE-RM @ $1.35, expired worthless

Entry $39.75 (4/18)

VLO - $80.00 Valero Energy ** Stop $69.00 **

VLO gained +$6 for the week and is holding right at the prior resistance highs at $80. Valero announced on Friday that profit estimates were too low and said profits for Q2 should now be about $3 per share compared to analyst estimates for only $2.55. Valero said margins were soaring due to record high diesel prices and their ability to refine heavy sour crude. All excess production coming out of OPEC is now heavy crude and it sells at a steep discount to the benchmark light crude currently in short supply. VLO is in the right place at the right time! VLO refines about 12% of US gas/diesel supplies. 

Company Info 

VLO has been weak since the announcement it was buying Premcor. This should be a very good deal for them and the combined companies will control a large portion of the refinery business. Think of it as a buying opportunity. 

Valero is the largest independent refiner in the U.S. and one that has made the switch to the higher profit margins of sour crude. Oil prices are generally quoted using the West Texas Light Sweet price. The sour crude sells for significantly less and will become the dominant variety as oil supplies dwindle. Sour crude has been running about $10 a bbl under sweet crude. Valero is seeing even bigger discounts from less desirable grades from Mexico and Alaska. It costs more to process the sour crude and fewer refineries can handle it. This forces the price of that sour crude lower. Finished gasoline is priced basically on the price of a barrel of sweet crude. This means the same gas Valero produces from cheaper sour crude sells for the same price as the gas produced from sweet crude. This enables Valero to capture a significant profit margin. They had a record year in 2004 due in part to their ability to process the cheaper grade of oil. The company has already said 2005 profits will be higher in 2005 even if margins narrow for others. 

Company website: http://www.valero.com/About+Valero/

Valero reported earnings on April 21st of $1.92 that more than doubled the prior year of $.91 cents. VLO fell slightly in trading because analysts had estimates of $1.97. Shucks, they missed estimates by a nickel but more than doubled last year. Let's sell them. Duh! They rebounded as eager traders rushed into the gap and they closed at $74.86 on Friday, more than $5 above the earnings dip at $69.55. 

2007 $75 LEAP Call VHB-AO @ $14.10

Insurance put: 
June $60.00 VLO-RL @ $2.05

Entry $68.00 (4/15)

CVX - $59.02 Chevron Texaco ** No stop, New Put **

CVX finally broke free of the $56 resistance range and closed at a new two month high. However there is trouble ahead for Chevron. Rumors continue to flow that CNOOC, China National Oil Company could be ready to make a higher offer for Unocal that could be as much as +10% over Chevrons existing offer. Personally I doubt Chevron will let Unocal go and will also up its bid. This could further depress CVX stock prices if a bidding war develops. The June put expired worthless and with the potential for a bidding war I am adding the Sept $55 put this week as additional insurance. 

Company Info

Chevron spiked to $54.50 on May 6th on news of an oil find in Utah by Wolverine where Chevron has extensive leases. It was also announced that Chevron had won a portion of the 15 blocs up for bid in Libya. 

Chevron posted earnings that disappointed the street due to several unplanned outages at various refineries. CVX saw refining profits fall -36% but the condition is expected to be temporary. The stock is also weak due to uncertainties about the Unocal acquisition. 

Chevron announced in early April that it was purchasing Unocal for $18 billion in cash and stock and both CVX and UCL dropped sharply. This was not a surprise for Chevron to make the purchase but the timing caught everyone off guard. 

In theory everyone was waiting for oil to drop in Q2 and allow the next round of acquisitions to be made at a more reasonable value. Instead Chevron did a take under on Unocal by offering less than the current share price. It is a good deal if you can pull it off. 

Chevron beat out several other firms including China's CNOOC who had been a hot pursuer but had to drop out at the last minute after it could not complete the final terms in time. 

Chevron will likely sell off about $3 billion in non-core assets once the deal is consummated. The main asset Chevron wanted was the 1.7 billion barrels of proven reserves and tens of thousands of acres of additional leases still to be explored. Chevrons current average cost of produced crude is $27. After selling the non-core assets they will end up with the Unocal proven reserves at about $9 a bbl plus billions in other assets like gas fields, power plants and joint ventures around the world. This was a very sweet deal for Chevron. 

It may take some time for the cloud to lift from the stock price but the next jump in oil prices should do wonders. Chevron dropped back to its 100-day average at $55.50 on the news and this should be very strong support. There is not expected to be any hurdles to getting the deal approved as most of the assets are either out of the country or will be divested as part of the deal. 

The Unocal leap was actually triggered when the price hit $59 on the announcement. With UCL trading at $58.74 at Friday's close there would not have been any material movement. Because any Unocal leap will eventually end up being a Chevron leap I am electing to use the previously recommended Chevron leap as the actual position. I am using Friday's close for the entry price. 

2007 $60.00 LEAP Call VCH-AL @ $5.60
2007 $57.50 LEAP Call VCH-AY @ $6.70
Reference: 
UCL 2007 $60 LEAP Call VCL-AL @$6.60

We held both CVX and UCL leaps when the buyout was announced. I dropped the UCL listing as a duplicate to focus on the eventual merged company. Anybody holding the UCL leaps at the time should still be in them and ready to benefit from a higher UCL bid by CNOOC.

Insurance Put: 
June $55 Put CVX-RK @ $1.65, expired worthless

New Put 6/19
Sept $55 Put CVX-UK @ 0.95 

Entry $56.67 (04/07)


Leaps Trader Watch List

After several weeks of wandering CCU is still stuck in its trading range. Although I still expect CCU to eventually trade lower I have lost my patience. I am dropping it from the list. 

EBAY has found a bid once again without dipping to our $34 entry target. I am dropping it also. 

I am going to focus on energy stocks for the rest of the year. Should a golden opportunity appear outside the sector I will consider it but my focus will be on energy. 

December oil closed over $60 on Friday and that could have serious implications for the sector. Now that the psychological $60 level has broken we could see a strong short squeeze. Yes, there are shorts in this market. 

Talisman Energy, a takeover target I profiled here last week rose to a new high at just over $38 and stops should be placed just under $36. Congratulations to those readers who took the trade. 

I am not going to make them trades this week but I read several articles about the shortage of cement. Evidently many builders are on allocation for cement due to extremely high global demand. Many contractors and cement plants are having to layoff workers because they can't get enough cement. 

The major players in this sector are CX, FRK, LAF and EXP. Eagle Materials is a relatively new IPO and has risen from $55 to $95 over the last year. EXP distributes cement, Gypsum wallboard, recycled paperboard, concrete and crushed rock. The last year saw record earnings with a +59% growth. The Jan-06 $100 calls are just over $5 and with summer the highest demand season those profits are sure to grow into the 4th qtr. I profiled this for those looking for an additional opportunity.

Haliburton, HAL, broke out to a new high last week as a cap on a very strong month long move. However, that move only produced a +$6 move. I like HAL as a company but not as an investment. It moves far too slowly for me. However, HAL is about to split into two parts, one construction, one drilling. This should release substantial value for shareholders. The breakout last week could be the beginning of a new surge ahead of this split. The Jan-06 $47.50 calls are only $3.70. 

I wanted to add DO, Diamond Offshore to the watch list this week but options for DO are obscene. The slightly out of the money 2007 LEAP was nearly double the price of the COP leap with both stocks in the low $60 range. Considering the upside of both companies the situation should be reversed with COP LEAPS having a significantly higher price. Avoid DO leaps. 

I also wanted to add RIG as a leap candidate but option prices were also very high. Research also found that RIG had seen revenues fall in Q1 although earnings rose. While I think RIG is a good long-term candidate for increased drilling activity I would hesitate to buy its leaps. 

I added Grey Wolf, GW, and BP to the watch list and will add some more next week. I want to see if this latest surge in oil prices sticks or we get a massive pullback from touching the electric rail at $60. 

Dropped Entries
EBAY
Ebay, Inc.
CCU  Clear Channel Communications

New Watch List Entries
GW
$7.50
Grey Wolf
BP $64.00 BP Plc (formerly British Petroleum)

Current Watch List

GW - $7.50 Grey Wolf Inc

** Breakdown Target $7.00 **

Grey Wolf, Inc. is a provider of contract land drilling services to the oil and gas industry. For the three months ended 3/31/05, revenues increased 99% to $150M. Net income totaled $23M, vs. a loss of $6.4M. Revenues reflect ongoing efforts for U.S. land drilling and a higher number of rigs working at higher day rates as well as solid results from the turnkey operations.


Breakdown Target
BUY 2007 $7.50 LEAP Call OKW-AU currently $2.65

************************* 

BP - $64.60 Diamond Offshore 

** Breakdown Target $62.00 **

BP p.l.c. produces & markets crude oil & petroleum products worldwide. It is involved in exploration and field development throughout the world and is engaged in the manufacture and sale of petroleum-based chemical products. For the 3 months ended 3/31/05, revenues rose 15% to $81.01B. Net income rose 34% to $6.60B. Results reflect increased sales from all the business segments, higher marketing & refining margins and inventory gains


Breakdown Target
BUY 2007 $65 LEAP CALL WAO-AM currently $7.80


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