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Weekly Newsletter, Saturday, 06/25/2005

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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

Oil Hits New Record High 

I could probably have copied my commentary from last week into this space and nobody would have noticed. Oil continues to hit new highs and nobody should be complaining. 

The major story for this week was the final emergence of the CNOOC bid for Unocal. The bid at $67 was $2 billion better than the Chevron bid at $60 but there are huge regulatory hurdles to cross. The bid ignited a firestorm of controversy and calls to have it vetoed for reasons of national security. The $67 bid by CNOOC represents $11.50 per bbl of proven Unocal reserves. 

Chevron announced they would not raise their bid because they had a firm agreement and it represented the best chance of completion. They obviously will wait until there is some danger of the CNOOC bid surviving before upping their offer. No reason to panic until the roadblocks begin to fall. Because there is a strong potential of Chevron eventually raising their bid the price of CVX stock fell over the last two days. This is why I added the new insurance put at $55 last week. We are well protected through September and can watch it play out from a position of relative safety. 

Another analyst speculated last week that the eventual loser of the Unocal acquisition could quickly turn their sights to Marathon as a potential acquisition target. For that reason MRO has found a bid and refused to dip with the other energy stocks this week. I did my research and I think they might have a point here so I am adding it this week. 

XOM dropped sharply this week by nearly -$3 with the majority of the drop in the last two days. This suggests to me it is a rebalance issue with the Russell. With oil closing at record highs and other oil stocks holding the line there is nothing to suggest a reason for selling in XOM. However, XOM has very large institutional interest and some could see $60 oil as a top and they are shifting out of slow moving XOM and into other sectors as the quarter ends. This could be a window dressing move. 

Boone Pickens said on Friday that we would see $3 gas this year and $100-$120 oil within five years. That scenario would effectively kill the notion for long-term investors that oil has topped at $60.

I removed EBAY from the watch list last week for lack of movement and it promptly fell to within 10 cents of our prior entry target at $34. Last week I mentioned plans for keeping the portfolio purely energy until the fall but I really think the factors surrounding EBAY warrant consideration by readers. I suggested a short-term call in the Market Monitor on Friday using the July $35 call at 95 cents. Leap Traders might want to consider the August calls at $1.90. Because of the potential for a late July market drop I would hesitate to hold the position more than a couple weeks. 

My EBAY reasoning is three fold. I believe much of the end of week drop was related to the Russell rebalance process and that pressure should be over. Secondly Ebay held its 10th anniversary convention this week and there were many new and promising developments hitting the wires. Thirdly and most important, David Faber on CNBC is doing an EBAY profile on the 29th just like he did on Wal-Mart several months back. They ran the Wal-Mart profile about a dozen times a week to start and are still running it as filler on the weekends. I believe the EBAY profile will fill every available time slot for the next month. This should provide strong investor interest and $34 appears to be a buying opportunity. 

If you took the DJX put trade two weeks ago and were not stopped out with me on the 10650 spike then you are doing very well. The put is up +40% from our entry price. I would be cautious next week as a bounce is possible. Everything came through as expected but that pesky spike took me out of the play. If we do get a rebound next week and into earnings I will be taking the trade again around expiration week in July.


Changes in Portfolio

New Plays
MRO
Marathon Oil

Dropped Plays

None


New Watch List Plays Triggered

None


Portfolio Listing & Top Picks


New Plays

Most Recent Plays

4 HEADER, begin SECTION 4 BODY-->

MRO $54.74 Marathon Oil ** No Stop **

Only one company will end up with Unocal and that leaves the other hungry and looking for other targets. XOM also has nearly $30 billion in cash and needing to make an acquisition. Marathon is one of the largest remaining independents and a likely target due to its diverse operations. MRO has several large properties in Asia and within China's sphere of influence. 

MRO has held the high ground this week near $55 and appears ready to break out to new highs if oil moves over $60. Options are relatively cheap and insurance against a breakdown is less than a buck. 

Company Info:

Marathon Oil Corporation (Marathon) is engaged in worldwide exploration and production of crude oil and natural gas. It operates through three segments: exploration and production (E&P), which explores for and produces crude oil and natural gas; refining, marketing and transportation (RM&T), which refines, markets and transports crude oil and petroleum products, and integrated gas (IG), which markets and transports natural gas and products manufactured from natural gas, such as liquefied natural gas (LNG) and methanol. The Company's principal operating subsidiaries are Marathon Oil Company and Marathon Ashland Petroleum LLC (MAP). During the year ended December 31, 2004, the Company's worldwide liquid hydrocarbon production averaged 170,000 barrels per day (bpd) and sales of natural gas production, including gas acquired for injection and subsequent resale, averaged 999 million cubic feet per day (mmcfd).

Remember this? I dropped MRO as a LEAP play back in January after a month (December) of flat performance. Can I have it back please?

MRO Chart reflections

Current entry: 

Buy 2007 $55 LEAP Call VXM-AK currently $7.90

Put insurance
Buy August $50 PUT MRO-TJ, currently 85 cents, ONLY 
if MRO trades at $52.50. I do not want to buy the insurance until it is needed. 

Entry $54.74 (6/27)


Play Updates

Existing Plays

CHK - $23.05 Chesapeake Energy ** Stop $20.50 **

CHK surged to a new high at $24 on Monday and pulled back slightly on profit taking. $23 support appears to be holding as we await the next round of oil price increases. 

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)

APC - $82.62 Anadarko Petroleum ** Stop $74.00 **

APC broke out to another new high on Thursday near $85 and pulled back only slightly to rest. APC is doing very well and bidders appear on every dip. 

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 - $58.12 Conoco Phillips ** Stop $52.00 **

Like Crude oil COP surged over $60 early in the week. Late week profit taking saw it slide back to $58 but that support held. COP is still my favorite major oil with large reserves and aggressive management. 

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 - $78.95 Occidental Petroleum ** Stop $73.00 **

OXY broke out to a new high once again on Thursday at $81 and held its gains very well. Support at $78 was tested twice and both times it held. OXY has been getting a lot of positive press with Merrill raising its target to $88 earlier in the week. Merrill is well behind the curve on oil but they have been good about raising their targets once they are passed. Their prior target was $77. 

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 - $58.17 Exxon Mobil ** No Stop ** 

XOM was the worst performing stock this week with a sharp drop on Thr/Fri. This suggests it was index related or that funds are taking profits and shifting into a faster mover. XOM has very heavy institutional ownership and about 6 billion shares. This makes strong gains hard to achieve. It also has the largest reserves of any company and many countries. With $30 billion in cash there is also fear they will make an acquisition at what seems to be high prices to many. 

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 - $44.93 Energy SPDR ** Stop $41.50 **

The XLE is also holding near its recent highs at $46 set on Monday. The various sectors represented by the XLE gives it diversity for strength. This allows minor swings by a given sector to be offset by gains in the others. 

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)

CVX - $56.77 Chevron Texaco ** No stop, New Put **

CVX cratered on the CNOOC announcement after holding near its recent highs at $59.50 for most of the week. Investors are worried that Chevron will raise its offer to battle CNOOC and they are taking profits from the May rebound from $50. Our new insurance put we added last week at $55 should protect us. 

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. CNOOC has since offered $67 a share for Unocal but the deal is expected to fail due to a lack of approvals. 

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

The touch by crude at $60 produced no real drop in oils. There was some minor profit taking but much of it could be attributed to light profit taking and index rebalance issues. We are also approaching month end and funds may want to lighten exposure to oil and "appear" more diversified as the quarter ends. 

We did not hit a trigger on the two entries from last week, GW and BP, and I added MRO as a play this week. I want to keep the portfolio around ten positions and will continue to keep the watch list light. 

I am adding Encana Corp this week as another watch list entry. ECA owns the largest independent gas storage network but that is not the primary focus of its business. ECA has been divesting itself of non-core assets in an effort to focus on its main business. It will divest itself of the gas network either through a competitive bid or IPO by early 2006. This represents a major cash generation point for ECA and they will use the cash to acquire more reserves. This is the kind of story we want in our LEAPS portfolio. Unfortunately ECA does not have leaps and we will have to use the Jan-06 calls. That should get us through the Fall demand cycle and allow us to take profits ahead of the spring dip. 

Dropped Entries

None


New Watch List Entries
ECA
$40.76
Encana Corp

Current Watch List

GW - $7.26 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 - $63.50 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

************************* 

ECA $40.76 Encana Corp

** Breakout target $42.00 **
** Breakdown target $39.00 **

Company info:

With an enterprise value of approximately US$44 billion, EnCana is one of North America's leading natural gas producers, is among the largest holders of gas and oil resource lands onshore North America and is a technical and cost leader in the in-situ recovery of oilsands bitumen. EnCana delivers predictable, reliable, profitable growth from its portfolio of long-life resource plays situated in Canada and the United States. Contained in unconventional reservoirs, resource plays are large contiguous accumulations of hydrocarbons, located in thick or areally extensive deposits, that typically have low geological and commercial development risk, low average decline rates and very long producing lives. The application of technology to unlock the huge resource potential of these plays typically results in continuous increases in production and reserves and decreases in costs over multiple decades of resource play life. (source Encana)

Encana does not have leaps so we are going to use the January-06 calls. The demand cycle runs through November giving us plenty of time to rotate out and reenter on the spring demand dip. 

Breakout Target
BUY Jan 2006 $45 CALL ECA-AI currently $2.50

Breakdown Target
BUY Jan 2006 $40 CALL ECA-AH currently $4.60


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