Table of Contents
Leaps Trader Commentary
Warm weather continues to be the biggest problem for energy investors. A build in inventory levels last week has extended the streak and continues to pressure prices. If you remember the same forecasters that predicted a stronger than normal hurricane season also predicted a colder than normal winter for the northeast. So far that prediction has yet to come true but winter lies just ahead.
Predictions for a cold front this weekend did provide support for natural gas prices, which refuse to break below $11. Oil prices declined to $57 on Friday and various futures houses are talking about a test of $55 or even $50. The break below support at $59 took out the 200-day average at $58 for the only break in more than two years on the December contract. On the continuous crude contract, @CL.P on TradeStation the 200-day was pierced briefly in June-2005 for the only break since Nov-2002. It has dipped to the 200-day numerous times since 2002 but each time resulted in a rebound.
Personally I would think this touch of the 200 on the December contract would be a buying opportunity but there are still too many factors impacting price to take the plunge. On Thursday the IEA cut estimates for winter demand by -400,000 bpd due to unseasonably warm weather. The market reacted to this news while ignoring the rest of the report. The IEA also said that there was little evidence of a country-wide drop in demand due to demand destruction from the price spike. They said demand could be understated and could increase the need for crude from OPEC as winter progresses. They likened the current calm weather as the eye of the storm with a strong likelihood of a new period of volatile weather once this calm passes.
The IEA said Chinese oil demand in September surged +9% led by a huge jump in gasoline consumption of more than +14%. This bumped their daily consumption to 7 mbpd and solidifying their position as the second largest oil consumer in the world. The IEA also said global Q4 demand would rise to 85.5 mbpd, slightly over the 84 mbpd currently being produced. The IEA projected demand table below puts this into perspective.
Projected 2006 Demand Compared to 2004/2005 Actual
I attended the 2005 PEAK Oil Conference last week and nothing has changed from the 2004 outlook. If anything the situation is accelerating. I am not going to repeat the 2000 word commentary from this weekend's Option Investor newsletter. Please see that commentary for a better description of the long-term problem.
As energy investors that leaves us with a problem. We should be seeing a rise in oil/gas prices as winter demand kicks in but the warmer weather has not only postponed that demand but is erasing the impact on a daily basis. Every day that passes without increased demand allows a further build in inventory levels. Those levels will control the price for the rest of the winter.
Q1 demand is normally only slightly less than Q4 but the inventory buildup for Q1 occurs in Q4. This means price appreciation normally occurs in Q4 and the warm weather is negating that spike. It may still occur but I am not hopeful it will return us to the Aug/Sept levels.
If you will look at the table above you will see there is normally a pause in demand in Q2 as winter demand eases before summer driving demand increases. This is where I have repeatedly suggested we want to be buyers. Any demand slump in late Q1, early Q2 is our buying opportunity ahead of the Q3/Q4/Q1 demand cycle.
Our problem today is the demand lull. I had hoped to ride the Q4 demand bounce into late December before exiting to sit on cash until the March dip. With no Q4 bounce there is little to play. We can continue to nibble at positions here at the 200-day average but the risk reward ratios are slim. Each position will require insurance to protect against an oil drop to even lower support at $51. Gas positions should continue to rise once winter weather appears. Gas is less susceptible to the fluctuations of oil since so much of the U.S. is either heated by gas or from electricity from gas.
Despite a positive long-term environment for coal we saw a dramatic sell off in coal this week. BTU fell from $82 to $72 in slightly more than one day on the confluence of demand pictures for gas and oil. Nothing changed in the coal sector and utility companies are still adding to stockpiles in advance of the cold. It is just the added volatility that is produced by the lack of a trend in all energy sources. The energy sector is suffering from a very strong run that lasted for more than two years. BTU was trading at $9 in July of 2003. It is only natural that we should see volatility at this level with oil in a two month down trend. Eventually the energy trend will resume. It is only a matter of time but we must be patient through the various stutter steps until the trend resumes.
One reader suggested shorting energy stocks over this period but the problem remains in the fundamentals. The fundamentals for energy are very bullish and we are approaching the mother of all spikes once PEAK Oil arrives. I believe we will never know when the next uptick is the one that eventually goes to the moon. It will occur when that first oil buyer attempts to contract for oil delivery and there is none available. That will be the domino that starts a decade long chain reaction. With that view I feel it is not in our best interest to short energy. I would rather look for bottoms to form in individual stocks and take long-term positions with insurance. Let's keep our eye on the ball and not be distracted with short-term fluctuations.
Natural Gas Chart - Daily (390M)
Crude Oil futures Chart - Daily
Crude Oil Futures Chart - Weekly
Changes in Portfolio
Portfolio Listing & Top Picks
Most Recent Plays
VLO - $96.17 Valero ** Stop loss $91 **
Exit target $108
Valero had the stuffing knocked out of it over the last two weeks. VLO fell from a high of $111 to a low of $95 and a dead stop on its 100-day average. The rebound was lackluster given the break of $59 by crude futures. We are in about the best position we could be in at this time with VLO on support and glimmers of demand on the horizon. If the cold weather appears this weekend as some forecasters expect then crude could rebound taking VLO with it.
There is an interesting chart on the option VLO-AB. Look at a daily chart and you can see where somebody literally sat on $13.10 for a month selling every spike. This is the most visual occurrence of resistance I have ever seen.
Valero will split 2:1 on Dec-16th. We will want to exit before the split.
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.
January $110 Call VLO-AB @ $5.50
LEAPS are far too expensive and I would expect to be out of the trade by Christmas at the latest.
Exit target $108
Entry $100 (11/09)
CHK - $27.43 Chesapeake Energy ** No Stop **
CHK imploded at the open on Monday and triggered the insurance put at $28. It appeared to stop at this level until the oil crash on Thursday. We are fully protected with an April put so this will be a long-term position. Banc America reiterated a buy on CHK last week with a price target of $43. CHK continued on its acquisition spree by acquiring 19% interest in Gastar Exploration and 33% interest in some of its properties in Texas.
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
Entry $29 (11/04)
UPL - $50.90 Ultra Petroleum ** Stop loss $45 **
We dodged a bullet on UPL this week with our stop loss at $48 and the post oil crash dip to $48.50. The rebound was lackluster due of course to the lack of a rebound in crude. UPL is primarily a gas producer and cold weather should produce a rebound in gas ad UPL.
I am adding an insurance put this week but only if UPL trades at $48.50 again. I also lowered the stop.
Headlines from their earnings on Oct-26th:
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
Insurance Put: Dec $45 Put UPL-XI
Entry $55 (11/02)
STR - $76.62 Questar Corp ** Stop Loss $70 **
Questar held its ground very well considering the carnage in the energy sector. The trading range from $76-$80 is still in place and it appears to be waiting for the cold weather. No change in plan here.
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.
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
Entry $78.76 (10/31)
COP - $63.53 Conoco Phillips ** Stop Loss $59 **
Conoco took the mandatory drop with the rest of the sector but appears to be marking time well over support at $60. COP is still my favorite big oil stock. COP will hold its annual analyst meeting on Wednesday and it will be webcast live at www.conocophillips.com/investor. I expect them to be very positive and explain the development plans for Russia. This could supply a boost for the stock price. COP is the most aggressive big oil in attempting to acquire reserves. Their exploration budget for 2006 increased by +127%.
Earnings were Oct-27th
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 - $74.80 Altria Group ** Stop Loss $71.00 **
MO is wedging back up to resistance at $75 and hopefully we will get a solid break on this trip. With the market in rally mode heading into the holidays this is a relatively safe stock for institutions given their coming attractions.
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.
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
Buy the put now instead of on a trigger since legal announcements tend to appear suddenly.
Entry $75.00 (10/31)
UNH - $59.60 Unitedhealth Group ** Stop Loss $50 **
UNH has rebounded from the November dip and is back within 30 cents of a new all time high over $59.90. Health care typically does well in Q4 and hopefully the weakness has worn off with the market in rally mode.
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.
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
Entry $56.75 (10/31)
BTU - $76.13 Peabody Energy ** Stopped $73.00 **
The drop in BTU was extremely frustrating given the large amount of profit we had built up in the position. I had left the stop low thinking we could survive the volatility and it dipped just enough to trigger that stop at $73. Fortunately we only lost -50 cents because our entry point was also low. I will continue to own BTU personally but I am not going to play it again in the LEAPs portfolio until a new trend is established.
Earnings were OCT-18th
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, exit $6.20, -0.50, 11/10
Entry $73.88 (10/23)
Leaps Trader Watch List
We were triggered on the VLO entry last week but Sunoco failed to dip to our $70 target although it came close twice. I looked at dozens of potential targets for this week and lusted over the drop in AHC but I could not make it work in terms of risk/reward.
The drop in oil on Thursday continued the decline we have been seeing for two months. Until that decline channel is broken any long targets contain high risk.
I am going to leave SUN as our only watch list item at $70 because refiners will be the first to recover once winter demand returns. Refinery margins will grow due to the lower cost of oil and the potential rise in the cost of refined products.
Any new play should be short term with a target to be out by the end of December.
Using that scenario I would continue to trade AHC on a very short-term basis.
The dip we saw to $122 last week may be a strong entry for the next breakout
attempt at $131. Use your own judgment and try to buy the bottom and sell the
top of this highly volatile stock.
Current Watch List
SUN - $73.38 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
Breakout Target: NONE
Option Investor Inc is neither a registered Investment Advisor nor a Broker/Dealer. Readers are advised that all information is issued solely for informational purposes and is not to be construed as an offer to sell or the solicitation of an offer to buy, nor is it to be construed as a recommendation to buy, hold or sell (short or otherwise) any security. All opinions, analyses and information included herein are based on sources believed to be reliable and written in good faith, but no representation or warranty of any kind, expressed or implied, is made including but not limited to any representation or warranty concerning accuracy, completeness, correctness, timeliness or appropriateness. In addition, we do not necessarily update such opinions, analysis or information. Owners, employees and writers may have long or short positions in the securities that are discussed.
Readers are urged to consult with their own independent financial advisors with respect to any investment. All information contained in this report and website should be independently verified.
To ensure you continue to receive email from Option Investor please add "firstname.lastname@example.org"
Option Investor Inc