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Weekly Newsletter, Saturday, 11/05/2005

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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

No Blizzards Yet

Winter demand for heating oil and natural gas has yet to be seen as the northern areas continue to bask under balmy skies and mild temperatures. Natural gas finally broke support at $12 and dipped to end the week at $11.40 despite a smaller than expected injection into reserves. Reserves rose only 29 bcf to 3,168 bcf for the week ended on Oct-28th. This was below the average injection for that week of 79 bcf. Gas storage is now 3% above the five-year average thanks to the warmer weather and lack of demand. Remember, there is insufficient production and pipeline capacity to supply winter demand and getting through the winter without shortages depends on building up storage supplies ahead of the cold weather. 3,200 bcf is the level needed to supply a cushion in normal years.

I did not add any gas plays last week pending the start of winter demand and it appears to have been the right decision. I know most investors are thinking gas prices will continue lower but I still believe we are in for a shock once the thermometer begins dropping. All we need to see is a couple negative weeks for gas injection and prices will quit dropping.

Baker Hughes, BHI, weekly rig count said the number of rigs drilling for natural gas rose to 1,260 an increase of 13 from the prior week and +183 over the same period in 2004. Active oil rigs rose to 231 in the U.S. and Canada, an increase of +4 over the prior week and +41 over 2004. Note the difference between active oil exploration compared to gas exploration. Only 231 oil rigs in the entire U.S. and Canada. This should go a long way towards convincing diehards that there is little oil left to find on this continent.

Saudi Arabia announced last week it was going to spend $14 billion to raise output capacity from 11 mbpd to 12.5 mbpd by 2009 according to a report by Samba Financial Group, a Riyadh based bank. However, the International Energy Agency said oil prices could rise another 50% if Saudi does not invest additional billions for additional production increases. The IEA said Saudia must invest enough to double production by 2030 to avoid shortages but Fatih Birol, the groups chief economist, said the kingdom does not have the will to make the investment. Saudi is deep in debt and has the largest family welfare program in history. Over 30,000 members of the royal family receive from $17,000 to $270,000 per month in support from the family. Few Saudi men have jobs and depend on the family for income. 70% of government jobs and 90% of private jobs are held by foreigners. The kingdom would have to make substantial cuts in those welfare payments to raise the additional $100 billion necessary to increase production materially. That of course assumes they could increase production given the state of their fields. Water cut in the Ghwar field is said to be over 70% now meaning for every million bbls of liquid to reach the surface 700,000 are water and only 300,000 are oil. They are said to be injecting over 10 million bbls of water a day into the outlying edges of the fields to push oil towards the wells. This is a last ditch effort commonly used to squeeze the last remaining amounts of oil from a field. With a water cut this high it is doubtful they could increase production substantially regardless of how much money they spent. Birol said: "We may end up with much less oil from the Middle East than we demand. There is substantial risk of substantially higher oil prices if current investment in the Middle East is not stepped up substantially.

The IEA will issue its eagerly anticipated World Energy Outlook next week. Oil demand is expected to double by 2030 but global production is expected to top permanently at somewhere under 90 mbpd in 2006. Nobody has explained how these numbers will be eventually be reconciled. Demand could be projected to grow to a 200 mbpd but it will never happen because of limits to production. That is like saying my wife's spending could grow to $10,000 a month by 2010 but if I never give her more than $1,000 a month she would never get to that $10,000 number regardless of how much she tried. Oil is not like credit. You can use it if you don't have it.

The different agencies continue to ignore the obvious and paint the picture that oil will continue to flow if only we apply enough money to the problem. The price of oil paints a different picture. With oil holding steadfast over support at $59 it suggests those who actually buy the oil are facing a different set of realities. I said last week we are only marking time until the winter demand cycle appears and nothing has changed. Oil is holding and gas only dropped slightly on the inventory number. Eventually we will see demand rise and prices will begin to firm.

I also believe any price increases are only temporary and we will see another decline early in 2006. This will be our buying opportunity for the next year. Leaps will be cheap during the lull between winter heating oil and summer driving season. Refineries begin to coast in January and make the switch in early spring. That will be our window of opportunity. Until then we are going to keep the portfolio light and pick targets of opportunity as they appear for shorter term trades.

More than 20 energy companies report earnings next week so there is still some risk to individual names and sub sectors within the energy sector.

This week we saw both our watch list candidates be triggered as plays. That boosts us to seven active plays and about as many as I want to carry until energy begins a new uptrend. However, I believe the drop in refiners on Friday may have been an entry point ahead of the winter refining cycle. Once heating oil demand begins to ramp so will refiner margins and stock prices. I am adding one refiner to the watch list on hopes for a continued dip rather than a blind entry.

This week I am going to a PEAK Oil conference and should have a lot to write about next weekend.

Natural Gas Chart - Daily

Crude Oil futures Chart - Daily

 


Changes in Portfolio

New Plays

None


Dropped Plays

None


New Watch List Plays Triggered
CHK $29.04 Chesapeke Energy
UPL $53.25 Ultra Petroleum

Portfolio Listing & Top Picks


New Plays

Most Recent Plays

4 HEADER, begin SECTION 4 BODY-->

CHK - $29.04 Chesapeake Energy ** No Stop **

CHK reported earnings that were less than expected due to hedging agreements in place to cover secured payments for prior acquisitions. These were non-cash losses impacting the bottom line but investors were disappointed they were not reaping the full benefit of current prices. CHK said the agreements would run their course in 2006 and they were benefiting from the current prices on current new production.

The drop in gas prices late last week saw CHK briefly break support at $29 to trigger our breakdown entry. The insurance put was NOT triggered as CHK has yet to trade at $28. The tail on the 15:28 candle was a bad tick not an actual trade.

This play has a very good chance of being a long-term play. The insurance put at $1.80 at Friday's close is cheap insurance good until April giving us a long-term chance at higher prices over the winter.

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.

2007 $35 LEAP VEC-AG @ $4.00

Insurance Put:
April $25 CHK-PE if CHK trades at $28

Entry $29 (11/04)

UPL - $53.25 Ultra Petroleum ** Stop loss $48 **

UPL traded up to trigger our $55 breakout entry on Wednesday and traded as high as $56.15 on Thursday before giving in to profit taking on Friday to close at $53.25. The -$3 dip took it back to light support at $52-$53 and we should see a bounce from here unless oil prices crash on Monday.

As with any oil stock today we are hostage to the price of oil even though UPL is primarily a gas producer.

I know at least one reader took the option to sell a put rather than buy the expensive calls. This is no more risky than buying the stock as long as you cover it with a long put at a lower level. It would be hard to imagine any event that would send UPL drastically lower given their outstanding earnings but I am sure the Refco shareholders felt the same way a month ago. The object of selling the put is to buy it back later for a lesser amount. By selling the option the excess volatility premium works for you rather than against you. Try this experiment. Pick a stock with a decent uptrend and price a put $10 in the money (higher than the stock price) and a call at the same strike. Make a note to check back a month from now and check on the prices of both. I would bet the put has decreased in value more than the call has appreciated. Try to price both at the end of a day with no material stock activity. Obviously a multi dollar gain or loss on any given day will skew the option price for one or both options.

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.

MARCH $60 Call UPL-CL @ $5.20

No insurance put

Entry $55 (11/02)

 


Play Updates

Existing Plays

STR - $79.00 Questar Corp ** Stop Loss $70 **

Questar moved sideways for the week with investors confused about its relationship to gas. Questar is a diversified company with its talons in almost every area of U.S. gas exploration, production, trading, distribution and marketing. Because of its diversification should provide less risk going forward but a sharp drop in gas could be damaging from guilt by association.

STR did not trade below $75 so we are still naked on the Put insurance. We are not going to buy the put unless we are hit with a decline. I would rather not stop, reenter, stop, reenter and therefore the wide stop and the potential for put insurance instead of a tight stop.

Company Info:

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.

April $85 Call STR-DQ @ $5.60

Insurance Put
Buy December $70 Put STR-XN should STR trade below $75

Entry $78.76 (10/31)

COP - $66.20 Conoco Phillips ** Stop Loss $59 **

Conoco rallied sharply early in the week and failed to give much back on Friday. Conoco announced that their budget for exploration in 2006 would rise by +127% compared to Exxon's +25%. Rather than rest on their reserves COP is dedicated to increasing those reserves. COP is still my favorite oil stock for a long term hold.

Due to the rise in price I cancelled the potential put insurance and raise the stop to $59.

Earnings were Oct-27th

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.

2007 $70 LEAP Call OJP-AN @ $6.40

Insurance Put: Cancelled - no entry

Entry $63.25 (10/31)

MO - $74.03 Altria Group ** Stop Loss $71 **

MO failed to impress this week with an early week break over the resistance at $75 but a weak decline into Friday. This is a long term play based on the coming events but I would like to see an upward trend appear soon.

Yes, MO, not an energy stock but one with special events in its future. The tobacco suits and legislation appear to be winding down but MO is taking no chances. Altria is taking steps to distance itself from the eventual decline of the tobacco business and will be spinning off the tobacco side sometime in 2006. Altria I working to upgrade its non-tobacco image and will be divesting itself of other non-core assets. Barron's expects Altria to split into three separate companies in 2006 and release lots of pent up shareholder value. As long as Altria is hampered by the tobacco image and all the claims it can never receive a true valuation on the rest of its very profitable businesses. An insurance put is a must given the unpredictability of the legal cases.

Company Info:

Altria Group, Inc. (ALG), through its subsidiaries, Philip Morris USA Inc. (PM USA), Philip Morris International Inc. (PMI) and Kraft Foods Inc. (Kraft), is engaged in the manufacture and sale of cigarettes, tobacco products, branded foods and beverages. PM USA and PMI are engaged in the manufacture and sale of cigarettes in the United States and internationally, respectively. Kraft is engaged in the manufacture and sale of branded foods and beverages in the United States, Canada, Europe, the Middle East and Africa, Latin America and Asia Pacific. Kraft manages two units, Kraft North America Commercial (KNAC) and Kraft International Commercial (KIC). The Company operates in five business segments, such as Domestic tobacco, International tobacco, North American food, International food and Financial services, which accounted for 27.7%, 41.2%, 24.3%, 5.9% and 0.9%, respectively, of the Company's income during the year ended December 31, 2004.

2007 $80 LEAP Call VPM-AP @ $5.50

Insurance Put:
Jan $65 PUT MO-MM @ $1.25.

Buy the put now instead of on a trigger since legal announcements tend to appear suddenly.

Entry $75.00 (10/31)

UNH - $58.10 Unitedhealth Group ** Stop Loss $50 **

It was a great week until Thursday with UNH up to $59.90 before sector news cratered it on Thursday. Profit taking took hold and the Friday rebound was limited. The trend is still up and this should be just a pause. If we get any follow through next week I will cancel the put insurance and raise the stop. I just want to be careful considering the amount of profit in the stock.

UnitedHealth is the leader in the managed heathcare sector. Earnings are soaring, +31% in Q3 to $2.43 billion and the outlook is only up. With health care costs rising more and more companies will turn to UNH to lessen their benefit expenses. We are also expecting a seasonal bounce now that October is behind us. There were two strong sell cycles in October as funds took profits from a long period of gains. Historically health care companies have done very well over the next three months as funds look for safe havens for year-end cash. UNH gained +37% from the October lows for the same period in 2004. Buyers appear on every dip to the 100-day average currently at $53.

Company Info:

UnitedHealth Group Incorporated is a diversified health and well-being company, serving approximately 55 million Americans. The Company provides individuals with access to healthcare services and resources through more than 460,000 physicians and other care providers, and 4,200 hospitals across the United States. It manages approximately $60 billion in aggregate annual healthcare spending on behalf of more than 250,000 employer-customers and the consumers it serves. The Company conducts its business primarily through four operating divisions: Uniprise, Health Care Services, Specialized Care Services and Ingenix. On July 29, 2004, the Health Care Services business segment acquired Oxford Health Plans, Inc. (Oxford). Oxford provides healthcare and benefit services for individuals and employers, principally in New York City, northern New Jersey and southern Connecticut.

2007 $60 LEAP Call VUH-AL @ $6.40

Insurance put:
March $50 Put UHB-OJ if UNH trades below $54

Entry $56.75 (10/31)

BTU - $81.36 Peabody Energy ** Stop loss $73.00 **

Peabody had another stellar week but gave back -$3 on the Friday profit taking and the drop in gas prices. There is nothing on the horizon that could impact coal prices but lower gas can impact the stock price. We need winter weather to appear to push BTU to a new high over $87.

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)

 


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 have been watching my trading stock pick, AHC, you were probably amazed by the volatility over the last week. AHC rallied from $122 to over $131 in four days and only gave back -2.39 on Friday. This is a remarkable rebound from the $110 low we saw eight days ago. This stock is far too volatile to play at this level in the LEAPS portfolio but another dip to the 100-day average at $122 could make a very inviting target.

The massacre in the refining sector on Friday left me wondering if we could see another dip next week back to support levels where an entry would be safer. I would love to play Valero but options and volatility are extreme. I am going to add them just in case we get a strong dip back to $100 but I am not hopeful. I feel our better chance is with Sunoco for a tamer but still profitable ride.

I am going to list both as candidates BUT ONLY TAKE ONE. Whichever hits the trigger first is the one we are going to play. The refiners are far too volatile to add them both at this time of year.

I am expecting gas prices to dip lower next week due to another warm weather forecast. Once that first really cold surge of artic weather hits the trend will change and we can board the gas train then.

Drillers have been moving higher but are approaching resistance after a strong set of earnings from that sector. I believe the story is already priced into those stocks and would rather pass. As production comes back online in the Gulf that tells me that repairs have been made and equipment companies like NOV are probably going back to business as usual.

We already have the best integrated oil in the portfolio (COP), the best gas producer (CHK) and the best coal stock (BTU). That leaves us hoping to snare a refiner and maybe another pipeline stock before settling down for our turkey dinner and a nap until late December. This is not the time of year for large energy portfolios but I do plan on keeping my eyes open for bargains.


Good luck!
 

Dropped Entries

None


New Watch List Entries
SUN
$72.68
Sunonco
VLO $105.50 Valero

Current Watch List

SUN - $72.68 Sunoco

Sunoco, Inc. operates through its subsidiaries as a petroleum refiner and marketer, and chemicals manufacturer with interests in logistics and cokemaking. Sunoco's petroleum refining and marketing operations include the manufacturing and marketing of a range of petroleum products, including fuels, lubricants and some petrochemicals. Sunoco's chemical operations consist of the manufacturing, distribution and marketing of commodity and intermediate petrochemicals. The Company's operations are organized into five business segments: refining and supply, retail marketing, chemicals, logistics and coke.

Breakdown Target $70
Buy 2007 $80 LEAP VUN-AP

Insurance Put:
December $65 Put SUN-XM if SUN trades at $68

Breakout Target: NONE

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

VLO - $105.50 Valero

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 $100
Buy January $110 Call VLO-AB currently $6.80

LEAPS are far too expensive and I would expect to be out of the trade by Christmas at the latest.

Stop loss $94

Breakout Target: NONE
 


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