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Weekly Newsletter, Saturday, 10/29/2005

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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

Marking Time

The energy earnings cycle has come and gone with various results depending on how much hurricane damage each company suffered. Exxon was the winner by far with profits of nearly $10 billion for the quarter. A number that is unimaginable to me and represents over $110 million per day in profits. Still XOM failed to perform in the market despite +79% profit growth and closed the week with a gain of less than a dollar. The reason is of course the more than six billion in outstanding shares and expectations by analysts for an even larger profit.

On the other side of ledger was Chevron which posted a profit of $3.6 billion, +$1.64 per share or +12% after the storms damaged almost every Gulf asset owned or operated by the company. Analysts had expected profits in the $1.91 range. Chevron lost 40 days of production at its 325,000 bpd Pascagoula Mississippi refinery for a loss of more than $600 million in profits. Chevron saw damage to refineries, platforms, pipelines and drilling rigs with an even stronger impact to profits expected in Q4. You would have expected investors to flee the stock after the strong Q4 guidance warning and only +12% rise I earnings but CVX finished like XOM with a gain of slightly less than a dollar for the week.

The only stock that really took a hit with earnings was Encana. It was also the only oil/gas stock left in the portfolio last week. "Was" is the keyword in that sentence. After resisting the prior week's downdraft on takeover rumors ECA plunged -$7 on lower than expected earnings and removed itself from our play list. Encana said a wetter than expected Q3 slowed drilling and completion efforts. Encana also said it suffered non-cash hedging losses related to its take over of Tom Brown Inc in 2004. Typically companies like Encana and Chesapeake pre sell a portion of production after an acquisition to guarantee debt payments and satisfy bank requirements. It is an easy way to finance acquisitions by using the acquired companies assets to pay the bill. In a situation like we have seen in 2005 with gas prices more than doubling that same hedging program returns to bite them as they are forced to sell that now current production at the much lower hedged rates. There is no free lunch. The Tom Brown Inc hedging program ends late in 2006. The non-cash loss was a mark to market write down of future production on the portion of production previously hedged. ECA also announced the CEO was leaving after 12 years and would be replaced by the CFO.

I did not add any new plays last week in advance of energy earnings because of the potential for earnings misses due to hurricane damage and the overactive expectations for earnings given the ramp in oil prices. That turned out to be a wise move in light of the volatility we saw in the market. The energy sector was not the only sector to see volatility with the Dow having its first triple-triple week of the year. That is three days of triple digit moves in the same week.

The price of oil continues to hover in the $60 range with strong support just over $59. Natural gas prices are barely holding over $13 after seeing injections into reserves of more than 75bcf for two consecutive weeks. Gas storage now stands at 3,139bcf and very near the 3.2tcf target needed by Nov-1st as a cushion for winter demand. Current production and existing pipelines are unable to satisfy winter demand and gas in storage must be increased to the 3.2tcf level ahead of the demand cycle to prevent shortages. Last winter we came within hours of shortages more than once as long bouts of cold weather produced a strain on those reserves. With forecasters calling for a colder than normal winter we should see that again this year.

11% of U.S. annual gas production has been lost and more than 50% is still offline in the Gulf. Eleven gas processing plants are still offline and are hampering a return to full capacity. A sudden cold front before that capacity is brought back online could start the winter off behind the curve and setup three tense months of watching the thermometer for relief. Without a sudden draw down we could see gas prices decline to support at $12. This is still a sharp increase from the $7 levels we saw last December.

With the oil price decline slowing and hurricane Beta making landfall into Mexico rather than continuing into the Gulf I am still cautious about rebuilding the energy portfolio. If you recall I had been expecting a seasonal decline in December but the storms and various market events like the multi billion dollar Refco liquidation skewed the price patterns and brought us all time high prices and a -$12 drop from those highs. The question now is of course what comes next?

After reviewing nearly 100 energy stocks this weekend the majority appear to have stabilized in the middle of their last four week trading range. While I have no problem entering a few speculative positions personally I have no desire to do that to any great extent in the portfolio. I can move quicker in my personal positions than I can in a weekly newsletter. I would like to see oil start a new upswing and move over $64 for confirmation before jumping back into the game. However, nothing ventured, nothing gained so I am adding my two best bets this weekend and we will hedge our plays with puts once again. I had not been using that option given the strong trend prior to September.

I am also going to add a couple non-energy plays. I received numerous emails asking what we were going to do while we waited out the seasonal weakness between the winter demand cycle and the start of the summer demand cycle. Since I do not want to be in the position of betting against oil that leave us with nothing to do if we don't dabble in other sectors. While the focus of the newsletter will continue to be energy ahead of the coming oil crisis it does not mean we can't profit from other opportunities as they appear.

Nothing has changed in my view on the coming energy crisis with 2007 still the target for a peak in global oil production and the beginning of an eventual permanent decline. I am going to a PEAK Oil conference in Denver in two weeks where I hope to get an update on the current forecast from Matthew Simmons, author of Twilight in the Desert. I will update everyone on what I find out.

Until then we are left trading what we see, not what we want to see. I was overly aggressive on buying the dips in early October in expectations of a rebound. For whatever reason that rebound did not come and we gave back some of our gains. That is no different than investors in other sectors given the broad market sell off and high volatility over the same period. There was some additional volatility in energy due to the Refco problem and with funds taking profits ahead of their October year-end. That should all be behind us now but until a new trend develops we are going to be cautious.

Remember my cautions about Conoco and their high profile TV ads prior to earnings? There was no surprise with their +89% rise in profits although expectations were dimmed by damage and lost refinery production. However, their strong advertising run ended abruptly once earnings were announced. COP gained +$7 in the four days prior to their earnings and only declined slightly afterwards. I still believe the heavy advertising campaign was an effort to manage expectations around earnings. Good job Conoco!

Check out the watch list section for some general thoughts on some riskier positions.

Natural Gas Chart - Daily

Crude Oil futures Chart - Daily

 


Changes in Portfolio

New Plays
STR $78.76 Questar Corp
COP $63.21 Conoco Phillips
MO $75.00 Altria Group
UNH $56.72 Unitedhealth Group

Dropped Plays
ECA $45.70 Encana ** Stopped $45.00 **

New Watch List Plays Triggered

None


Portfolio Listing & Top Picks


New Plays

Most Recent Plays

BTU - $76.60 Peabody Energy ** Stop loss $71.00 **

Peabody had another volatile week with a $9 range. Support appears to be holding at $73 but I raised the stop just in case another build in gas storage sends coal lower. BTU reported earnings that doubled the prior year but missed estimates by a penny. They were punished for that on the 19th and recovered back to the top of their range at $82. A drop in gas prices this week and likely end of year fund selling took them back to $73 but there was a strong buy on the dip. The risk here is gas prices and weather. Puts are still too expensive as an insurance option.

Earnings were OCT-18th

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 $80 CALL BTU-CP @ $6.70

Entry $73.88 (10/23)

ECA - $45.70 - Encana ** Stopped $45.00 **

Encana disappointed when they announced they were more than 80% hedged and were not taking advantage of higher gas prices. After four weeks of range bound trading the range broke to the downside and the outlook is for more of the same. Investors want aggressive plays and are not satisfied with boring.

Earnings were: 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.

APR 2006 $55 CALL ECA-DK @ $4.80, exit $3.70, 10/27 -$1.10

Entry $48.50 (10/13)


Play Updates

Existing Plays

BTU - $76.60 Peabody Energy ** Stop loss $71.00 **

Peabody had another volatile week with a $9 range. Support appears to be holding at $73 but I raised the stop just in case another build in gas storage sends coal lower. BTU reported earnings that doubled the prior year but missed estimates by a penny. They were punished for that on the 19th and recovered back to the top of their range at $82. A drop in gas prices this week and likely end of year fund selling took them back to $73 but there was a strong buy on the dip. The risk here is gas prices and weather. Puts are still too expensive as an insurance option.

Earnings were OCT-18th

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 $80 CALL BTU-CP @ $6.70

Entry $73.88 (10/23)

ECA - $45.70 - Encana ** Stopped $45.00 **

Encana disappointed when they announced they were more than 80% hedged and were not taking advantage of higher gas prices. After four weeks of range bound trading the range broke to the downside and the outlook is for more of the same. Investors want aggressive plays and are not satisfied with boring.

Earnings were: 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.

APR 2006 $55 CALL ECA-DK @ $4.80, exit $3.70, 10/27 -$1.10

Entry $48.50 (10/13)


Leaps Trader Watch List

Until the winter demand cycle appears I doubt we will see any material change in oil stocks. It is more of a trading market than an investing market until conditions return to normal.

If you took my suggestion on AHC last week you did well.

AHC - Amerada Hess - good trading stock. Buy under $110 or over $122.

AHC dropped from $121 to my $110 target after earnings and then rallied right back to $122 three days later. Far too quick for the newsletter but a gold mine for traders. Amerada Hess continues to puzzle me. While I like the stock for trading purposes the price action bears no resemblance to reality. AHC missed earnings by a mile, +$2.60 vs analyst estimates of +3.31 but after a nearly $11 drop it rallied back to close right near a new four week high. AHC even lowered Q4 production targets due to problems at several facilities not related to hurricanes. There is something going on under the covers with AHC and I would not be surprised to see a buyer appear. AHC would be a large bite for an acquirer with revenues in the $200 billion range. Insiders own more than 15% of the stock and the float at 92 million shares is relatively low. If we get that break over $122 I would definitely be a buyer.

The post earnings COP dip was less than expected but still a respectable trade from a low at $60 back to close over $63 on Friday.

APA - Apache never came close to my $55 dip target and appears to have strong support at $60. It might be worth gambling on it here but definitely be a buyer over $66.

TSO - Tesoro also failed to dip materially and a break over $62 could be a new trend in the making.

The official watch list will remain very skinny until a new trend appears. I am adding only CHK and UPL for breakouts


Good luck!
 

Dropped Entries

None


New Watch List Entries
CHK
$31.43
Chesapeke Energy
UPL $52.33 Ultra Petroleum

Current Watch List

CHK - $31.43 Chesapeake Energy

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.

Breakdown Target $29
Buy 2007 $35 LEAP VEC-AG
Insurance Put: April $25 CHK-PE if CHK trades at $28

Breakout Target $35
Buy 2007 $40 LEAP VEC-AH
Insurance Put: April $30 CHK-PF if CHK trades at $32

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

UPL - $52.30 Ultra Petroleum

Headlines from their earnings on Oct-26th:
Achieves record earnings of $60.9 million, up 118 percent from the same quarter in 2004.
Accomplishes record cash flow of $108.3 million, up 110 percent from the same period in 2004.
Attains record production of 18.7 Bcfe, up 44 percent over third quarter 2004 levels.
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.

Breakout target $55
Buy MARCH $60 Call UPL-CK currently $5.10

Stop loss $48

Suggestion only:

Another way to play the high premiums would be:

Sell 2007 $70 LEAP Put OZH-MN currently $23.00
Buy 2007 $45 LEAP Put OZH-MI currently $7.60

Larger account holders could buy the March put below to reduce the cost but still remain protected until March $45 put at $3.80.
You are betting with the market makers that UPL moves higher.
 


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