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Weekly Newsletter, Saturday, 10/01/2005

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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

Lump of Coal in Your Stocking

As we head into the holiday season with serious problems in the energy sector the prospect of getting a lump of coal in your Christmas stocking is actually a good thing. With nine weeks left in a very active hurricane season there is still a possibility of a third storm in the Gulf. Considering how badly damaged our Gulf production is a third storm could be the knockout punch. Burning that lump of coal may be the only heat we see by the holidays.

As of Friday afternoon 98% of Gulf oil production was still offline. 79.4% of gas production and 18% of refining capacity. I doubt an enemy attack could have inflicted that much damage all at once. Hurricane Rita damaged the oil sector much more than originally thought with damage to under sea pipelines still being found. Only 60% of existing platforms and 25% of existing rigs report ready to resume at least limited production once the undersea pipelines are repaired.

According to the Minerals Management Service 39 million bbls of oil production has been lost and that increases by 1.5 mbpd. That is roughly the equivalent of two tankers of imported oil every day. It represents 7.2% of our entire annual production and growing. Over 188 billion cubic feet of gas production has been lost representing 5.2% of our annual production at a time when we need to be building reserves not drawing down on them.

Three million bbls of refining capacity are offline and that is why we are not seeing $100 oil based on the loss of the Gulf production. We have more refineries offline than oil production so oil inventories are actually building up as each tanker of imported oil arrives.

This will change quickly. Over 1mbpd of refining capacity should be back online by the end of next week with another 350 kbpd due the following week. This should suck up any incoming oil and put us back in catch up mode. We will still have 1.5mbpd of refining capacity offline for at least 4-8 weeks according to the latest estimates. Higher prices and lack of demand from hurricane damaged areas is also helping moderate the impact of the disaster. EVENTUALLY, that demand will return as the recovery/rebuilding effort gains speed. At the same time there is no reduction of demand across the globe. China grew at +7% in the last quarter and India +4%. Their demand for oil continues to grow while we rebuild.

Make no mistake there is a crisis in energy and while prices appear calm today there is a severe storm ahead. The race is on to repair the damage to the production and distribution infrastructure before the winter demand kicks into high gear. Last summer we saw multiple dollar increases in oil when minor things like a fire on a 50Kbpd platform or a temporary outage in Nigeria or Ecuador. That is 1/30th of the current damage to Gulf production. Once refining comes back online the price of oil is going to rocket as the old refineries bid for light sweet crude.

Natural gas consumption is in the fall weather lull this week. Cooler temperatures mean less need for air conditioning but they are not yet cold enough to require heat. One good cold front and that Indian Summer consumption lull will be over for good. December gas rallied to $15 on Thursday and barely gave up ground on Friday. Profit taking was evident across the sector but it was very light. Since there is no strategic gas reserve the pipelines are running off gas stored locally but those reserves are rapidly shrinking in spite of what the "official" reports proclaim. A sudden cold front could easily push prices to $20 while panicked utility companies rush to get more coal.

That brings us back to the lump of coal. Peabody Energy (BTU) rallied to a new all time high on Friday but gave up ground in the end of day profit taking along with everyone else. Utilities see the handwriting on the wall and are rushing to add to coal supplies before the first cold front hits. While the gas companies will be the racecars for the months ahead, the coal companies, primarily BTU, will be the stealth tortoise that wins the race through steady gains. I suggested you add to your BTU positions last week and those that did were well rewarded. Continue to do so on any dip.

We did not lose any plays this week and picked up two positions on the Monday dip. (PBR, TSO) We missed adding a Valero position by 50 cents at $108 and it hit $117 on Thursday. I am going to add EOG Resources this weekend to round out our portfolio to 10 entries. EOG has 5.4 trillion cubic feet of gas reserves. Multiply that times $15 per thousand cubic feet. It is a scary number and obviously one that has no meaning other than the wow factor. Heck, with the potential for gas to go to $20 and higher over the next few years it might even be too low.

I am afraid I will have to raise all the stops again on the existing plays. It is a thankful job and I am very happy to do it! (grin)

Crude Oil Chart - Daily

Natural Gas Chart - Daily

 


Changes in Portfolio

New Plays
EOG $74.90 EOG Resources Inc. (Natural Gas)

Dropped Plays

None


New Watch List Plays Triggered
PBR $71.47 Petroleo Brasailiero (Integrated Oil)
TSO $67.20 Tesoro (Refiner)

Portfolio Listing & Top Picks


New Plays

Most Recent Plays

EOG $74.90 EOG Resources ** Stop Loss $70.00 **

EOG is a large independent producer of natural gas with a very strong growth profile. Recently EOG said they expect to post a +15% growth in production rates for 2005 followed by +9.5% growth in 2006. For 2006-2010 they estimated annual production growth of +7% to +11% per year on existing properties.

We played EOG earlier this year and were stopped out in the early July volatility. That stop cost us $15 in missed appreciation to the current price of $74.90. Gas was $8 back then as well. As we approach earnings for energy stocks EOG should ramp nicely as analysts start applying a +100% jump in gas prices in just over 90 days.

Earnings Scheduled: Nov-2nd

Company Info:

EOG Resources, Inc. (EOG) explores for, develops, produces and markets natural gas and crude oil primarily in major producing basins in the United States, Canada, offshore Trinidad, the United Kingdom North Sea and, from time to time, select other international areas. At December 31, 2004, EOG's total estimated net proved reserves were 5,647 billion cubic feet equivalent (Bcfe), of which 5,047 billion cubic feet (Bcf) were natural gas reserves and 100 million barrels (MMBbl), or 600 Bcfe, were crude oil, condensate and natural gas liquids reserves. At such date, approximately 50% of EOG's reserves (on a natural gas equivalent basis) were located in the United States, 25% in Trinidad, 24% in Canada and 1% in the United Kingdom North Sea. EOG's operations are all natural gas and crude oil exploration and production related.

BUY April 2006 $80 Call EOG-DP
(Leaps are too expensive)

Entry $74.90 (10/02)

TSO - $67.20 Tesoro ** Stop loss $62.00 **

Tesoro is a smaller refiner with only 558,000 bbls of capacity but half of that capacity is capable of refining heavy crude from Saudi and South America. This increases their profit margins substantially from those refiners only capable of refining light crude.

Because of this capability I would not be surprised to see them an acquisition target by a larger company. Higher margins normally attract bigger fish. TSO has been prepaying debt with the additional profits from these higher margins.

Earnings Schedule: Nov-4th (approx)

Company Info:

Tesoro Corporation (Tesoro), formerly Tesoro Petroleum Corporation, is an independent refiner and marketer of petroleum products with two major operating segments, Refining and Retail. Through its refining segment, the Company manufactures products, primarily gasoline and gasoline blendstocks, jet fuel, diesel fuel and heavy fuel oils for sale to a variety of commercial customers principally in the mid-continental and western United States. It operates six refineries in the United States with a combined rated crude oil capacity of 558,000 barrels per day. During the year ended December 31, 2004, approximately 50% of the Company's total refining throughput was heavy crude oil. Its retail segment distributes motor fuels through a network of branded gas stations, primarily trading under the Tesoro and Mirastar brands. The Company markets its products to wholesale and retail customers, as well as commercial end users. On November 8, 2004, the Company changed its name to Tesoro Corporation.

Feb 2006 $70 CALL TSO-BN @ $6.10
(LEAPs too expensive)

Entry $65.00 (9/26)

PBR - $71.47 Petroleo Brasileiro ** Stop Loss $66.00 **

PBR is very heavy into exploration and production and expects to spend $11.5 billion on upstream projects in 2005. On Wednesday they announced that three Japanese companies, Mitsubishi, Mitsui and Sumitomo had been short listed to buy an offshore block for up to $3 billion from PBR. Mitsubishi and Mitusi have already purchased interests in other Brazilian offshore fields. PBR is selling the undeveloped assets to pay for onshore exploration and production.

PBR announced on Thursday that it was going to build a new $2.5B refinery in Brazil and the Venezuela oil company PDVSA was going to share the cost 50:50. The refinery will be capable of refining heavy crude when completed in 2011.

Earnings Schedule: Nov-11th

Company Info:

Petroleo Brasileiro engages in the exploration for oil and gas and in the production, refining, purchasing and transportation of oil and gas products. For the last quarter reported, net revenues increased 35% to $10.73B. Net income increased 53% to $2.05B.

Petroleo Brasileiro S.A. - Petrobras (Petrobras) is a wholly owned government enterprise responsible for all hydrocarbon activities in Brazil. The Company also has oil and gas operations in international locations, with the significant international operations being in Latin American countries. Petrobras is engaged in a range of oil and gas activities, which include segments like exploration and production; refining, transportation and marketing; distribution; natural gas and power; international, and corporate. During the year ended December 31, 2004, the Company had estimated proved developed and undeveloped crude oil and natural gas reserves of approximately 11.82 billion barrels of oil equivalent in Brazil and other countries.

Breakdown Target @ $68.50 entry 8.10
BUY JAN 2007 $75 LEAP CALL VDW-AO

Entry $68.50 (9/26)

 


Play Updates

Existing Plays

ECA - $58.31 Encana ** Stop Loss $54.75 **

No stopping this rocket as natural gas prices continue to rise. ECA rose +$4 this week and closed at a new all time high on Friday. The rise in gas prices is reflected almost dollar for dollar in ECA stock. This is one of the largest pure play gas companies in the U.S. (Canadian actually) and continues to sell off non core assets to pay for premium gas properties. S&P just raised them to four-stars (buy) and an initial price target of $70.

Earnings Schedule: Oct-26th

Company Info:

EnCana Corporation is an independent crude oil and natural gas exploration and production company. Its key landholdings are in western Canada, the United States Rocky Mountains, Ecuador, the United Kingdom central North Sea, offshore Canada's East Coast and the Gulf of Mexico. EnCana explores for, produces and markets natural gas, crude oil and natural gas liquids (NGLs) in Canada and the United States. EnCana is also engaged in exploration and production activities internationally including production from Ecuador and the United Kingdom central North Sea. EnCana has interests in midstream operations and assets, including natural gas storage, NGLs gathering and processing facilities, power plants and pipelines.

JAN 2007 $50 CALL ZBM-AJ @ $7.10

Alternate short-term entry:
Jan-06 $50 Call ECA-AJ @ $2.50

Entry @ $46 (8/29)

BTU - $84.32 Peabody Energy ** Stop Loss $78.00 **

Another stellar week for BTU with a new high hit on Friday. The demand for coal is growing as the prices for gas are rising. This is the stealth play of the energy market.

BTU recently announced the opening of an office in China. BTU now claims to fuel 10% of U.S. electricity production and 3% of world electricity production. China is funding a $15 billion coal to gas/oil conversion project and BTU is the leader in the field. Power shortages in China require daily blackout periods and limit production shifts in factories to times when demand is weaker. Add to BTU positions on any dip above $79.00.

Company Info:

Peabody Energy Corporation (Peabody) is a private-sector coal company in the world. During the year ended December 31, 2004, the Company sold 227.2 million tons of coal. It sells coal to over 300 electricity generating and industrial plants in 16 countries. The Company owns, through its subsidiaries, majority interests in 32 coal operations located throughout all the United States coal producing regions and in Australia. Most of the production in the western United States is low-sulfur coal from the Powder River Basin. In the West, it owns and operates mines in Arizona, Colorado, New Mexico and Wyoming. In the East, it owns and operates mines in Illinois, Indiana, Kentucky and West Virginia. The Company owns four mines in Queensland, Australia. Most of the Australian production is low-sulfur, metallurgical coal. In addition to the mining operations, the Company markets, brokers and trades coal.

MAR 2006 $70 CALL BTU-CN @ $6.50
(no leaps)

Entry $67.25 (8/29)

UPL $56.85 Ultra Petroleum ** Stop loss $51.00 **

Ultra continued to lead the sector higher with a new high at $57.89 on Friday. This is a very strong gas play and while I expected it to rest this week, especially on Friday the end of the quarter, it soared once again. Eventually there will be some profit taking but I consider it a buying opportunity.

Earnings Schedule: Oct-25th

Company info:

Ultra Petroleum Corp. is an oil and gas company engaged in the development, production, operation, exploration and acquisition of oil and gas properties. The Company's operations are focused in the Green River Basin of southwest Wyoming and Bohai Bay, offshore China. During the year ended December 31, 2004, it owns interests in approximately 166,974 gross (92,997 net) acres in Wyoming covering approximately 260 square miles. The Company owns working interests in approximately 241 gross productive wells in this area and is operator of 41.5% of the 241 gross wells. Through Pendaries Petroleum Ltd., it is active in oil and gas exploration and development in Bohai Bay, China. The Company also owns interests in 15,518 gross (14,652 net) acres in Pennsylvania, as well as interest in approximately 720 gross (320 net) acres and interests in three productive wells in Texas.

Jan 2007 $45 LEAP CALL OZH-AI @ $8.40

Alternate short-term entry:
March $45 Call UPL-CI @ $4.40

Entry $40.00(8/22)

MRO - $68.93 Marathon Oil ** Stop loss $67.50 **

Marathon can't find any love with oil prices holding in the $65 range and problems with its refineries and pipeline business. Marathon has reopened its refinery on the Gulf and is accepting 550,000 bbls of crude from the SPR. Marathon is also facing a 50-day outage of its refinery near Detroit as it upgrades to the low sulfur fuels required in 2006. The outage was scheduled to begin soon and be completed in November. The outage will impact 74,000 bbls per day of capacity.

Marathon also operates the Centennial Pipeline to be back in operation next week at reduced capacity. The pipeline is expected to carry reduced capacity of 210,000 bpd until power is fully restored which could be 6-8 weeks from now. The pipeline runs from Beaumont TX to Illinois.

I tightened up the stop just in case the problems cause a continued drop in the stock.

Earnings Schedule: Oct-27th

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).

JAN-2008 $65 LEAP Call WXM-AN @ $6.50

Alternate short-term entry:
Jan-06 $65 Call MRO-AM @ $2.90

Entry $61 (8/22)

COP - $69.92 Conoco Phillips ** Stop loss $67.50 **

Conoco tried to set a new high on Friday but only came close at 70.25. Refinery outages in the hurricane zone is keeping COP on a short leash. We will continue to hold the play since an announcement of a return to operations should release the stock once again.

Earnings Schedule: Oct-26th

Company Info:

ConocoPhillips is an integrated energy company. The Company's business is organized into six operating segments. The Exploration and Production segment primarily explores for, produces and markets crude oil, natural gas, and natural gas liquids on a worldwide basis. The Midstream segment gathers and processes natural gas produced by ConocoPhillips and others, and fractionates and markets natural gas liquids. The Refining and Marketing segment purchases, refines, markets and transports crude oil and petroleum products. The LUKOIL Investment segment consists of the Company's equity investment in LUKOIL, an international, integrated oil and gas company. The Chemicals segment manufactures and markets petrochemicals and plastics on a worldwide basis. The Emerging Businesses segment encompasses the development of new businesses, including new technologies related to natural gas conversion into clean fuels and related products, technology solutions, power generation and emerging technologies.

JAN-2007 $65 LEAP CALL OJP-AM @ $7.50

Alternate short-term entry:
Jan-06 $65 Call COP-AM @ $4.40

Entry $63.50 (8/22)

CHK - $38.24 Chesapeake Energy ** Stop loss $34.50 **

CHK rebounded off the 100/130 averages and never looked back until Friday. CHK saw some decent profit taking from its $39 high but found support at $38. Continue to buy the dips on this gas play. CHK gets 90% of its income from natural gas and its average sales price in Q2 was in the $7 range. With prices nearly double CHK could reap a windfall depending on how much they hedged.

Earnings Schedule: Nov-4th (approx)

Company Info

Chesapeake Energy Corporation is an oil and natural gas exploration and production company engaged in the acquisition, exploration and development of properties for the production of crude oil and natural gas from underground reservoirs and the marketing of natural gas and oil for other working interest owners in properties that it operates. The Company's properties are located in Oklahoma, Texas, Arkansas, Louisiana, Kansas, Montana, Colorado, North Dakota and New Mexico. The proved oil and natural gas reserves as of December 31, 2004 were approximately 4.9 trillion cubic feet of gas equivalent (tcfe). At December 31, 2004, approximately 89% of the Company's proved reserves (by volume) were natural gas, and approximately 70% of its proved oil and natural gas reserves were located in the primary operating area, the Mid-Continent region of the United States, which includes Oklahoma, western Arkansas, southwestern Kansas and the Texas Panhandle.

JAN 2007 $30 LEAP CALL VEC-AF @ 4.90

Alternate short-term entry:
Jan-06 $30 Call CHK-AE @ $2.25

Entry $28.11 (8/28)

XLE - $53.69 Energy SPDR ** Stop Loss $52.25 **

The XLE gave up ground on Friday as profit taking appeared from the week long gains. The index diversity took us to very near a new high on Thursday so no damage done.

The XLE is a slave to oil prices given the makeup of the 27 component stocks. The biggest is XOM and it is a pure oil price play. The index has exposure to damage in the Gulf but also to companies that would repair the damage. That is the problem with indexes, you get the good, bad and ugly all rolled into one.

SPDR Description:

The XLE SPDR is composed of 27 energy stocks and represents about 9% of the SPX. This is the 9% 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.

List of XLE components: XLE List

JAN 2007 $55 LEAP CALL OJW-AC @ $3.50

Alternate short-term entry:
Jan-06 $50 Call XBT-AX @ $2.45

Entry $49 (8/22)

 


Leaps Trader Watch List

We were triggered on 50% of our watch list entries last week and only missed the other two by a few cents. Questar missed our entry at $82 by 75 cents before soaring to $88.78 on Friday. Valero missed our entry at $108 by 50 cents before soaring to $117.25 on Thursday.

I really wish we had scored on both of those as well since buying on a down draft always insures cheaper options. Now that they have run +10% in a week both are now expensive.

I fear the only way we are going to get into a Questar play is with a breakout entry but I hate to do that in this market and on top of those already strong gains.

Since we have a full portfolio at ten plays I am going to keep both of these targets on the list with breakdown entries only. We may never get them but if we do they should be almost instantly profitable on any rebound.

If you were watching on Monday as some readers were then you probably did not let these plays get away from you. I know several readers pulled the trigger when it was apparent they were not going any lower. Congratulations to everyone who took that action.

Good luck!
 

Dropped Entries

None


New Watch List Entries

None

Current Watch List

VLO - $112.95 Valero - refiner

STR - $88.03 Questar - gas production/distribution

**************************

VLO - $112.95 Valero

** Breakdown Target $110.00 & $108.00 **
** Breakout Target - none **

Valero Energy Corporation (Valero) owns and operates 15 refineries having a combined throughput capacity, including crude oil and other feedstocks, of approximately 2.5 million barrels per day. Valero produces environmentally clean refined products, such as reformulated gasoline (RFG), gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel, low-sulfur diesel fuel and oxygenates (liquid hydrocarbon compounds containing oxygen). It also produces conventional gasolines, distillates, jet fuel, asphalt and petrochemicals. Valero markets branded and unbranded refined products on a wholesale basis in the United States and Canada through a bulk and rack marketing network. It sells refined products through a network of more than 4,700 retail and wholesale branded outlets in the United States, Canada and Aruba. Valero's retail operations include approximately 1,500 company-operated sites that sell transportation fuels and convenience store merchandise.

Breakdown Target @ $110.00
BUY JAN 2006 $115 CALL VLO-AC

Add to position with a drop to $108.00, stop loss $106

*************************

STR - $88.03 Questar

** Breakdown Target $86.00 **
** Breakout Target - none **

Questar Corporation (Questar) is a natural gas focused energy company with three principal lines of business gas and oil exploration and production, interstate gas transmission, and retail gas distribution. Questar conducts most of its operations through its subsidiaries Questar Market Resources (Market Resources), Questar Pipeline Company and Questar Gas Company (Questar Gas). Market Resources is a sub-holding company that owns Questar Exploration and Production Company (Questar E&P), Wexpro Company (Wexpro), Questar Gas Management Company (Gas Management) and Questar Energy Trading Company (Energy Trading). Questar Pipeline provides interstate natural gas transmission, storage and gas processing and treating services. Questar Gas conducts retail natural gas distribution.

Breakdown Target @ $86.00
BUY APR 2006 $90 CALL STR-DR
 

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