Option Investor

Weekly Newsletter, Saturday, 04/26/2008

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Table of Contents

  1. Commentary
  2. Changes in Portfolio
  3. Portfolio Listing & Top Picks
  4. New Plays
  5. Existing Plays
  6. Watch List

Leaps Trader Commentary

Never A Dull Moment

U.S. ships shooting at Iranian boats, Nigerian attacks and strikes, Scottish strikes and U.K. pipeline shutdowns. What else could go right for oil prices on a Friday morning? Crude futures were declining nicely at $114.25 before the news began to break. Once the Iranian news hit it was an almost instant $5 ramp in prices right back to $119. Good news for energy stocks but bad news for our USO short.

I don't know which way to turn this weekend. The shutdown of the 700,000 bpd British Forties pipeline could put a real crimp in global inventories "IF" the strike lingers for several weeks. The Nigerian strike against Exxon could take another 200,000 bpd offline but I doubt this one will last long. Workers are conducting an orderly strike demanding better wages. Elsewhere in Nigeria MEND rebels blew up another Shell pipeline. The attacks in the prior week had already knocked another 169,000 bpd off line but there was no word on the damage from Thursday's attack.

With all these problems the upward pressure on prices could continue. If the Forties pipeline is restarted we could see a return to declining prices. We are never going to get rid of the violence in Nigeria and traders have pretty much become immune to the daily news from there.

Crude inventories rose by 2.4 million barrels but gasoline inventories fell for the sixth consecutive week. On the bright side refiner utilization spiked +4 percentage points to 85.6% from 81.4%. This is a massive jump and suggests refiners have started to produce the May fuel blends in quantity. That also suggests we could see crude inventories fall next week while gasoline inventories should rebound.

EIA Inventory Table

Reality warning: Skip to the play section if you don't want to read some disturbing news.

The last two weeks have seen a very large uptick in news items discussing the arrival of Peak Oil or at least the conditions similar to peak oil. That name seems to have polarized many people. They have been fighting against the peak oil scenario for years and now that it is coming to pass they can't afford to admit they were wrong. Instead they are penning articles referring to economic disruptions due to civil violence or nationalism of reserves. Instead of "geologic peak oil" they are calling it a political peak in oil production. The difference is only the reason for the declining production. In a political peak scenario the reserves to solve the problem still exist but are not being produced for various political reasons. In a geologic peak those reserves don't exist or cannot be extracted fast enough to keep up with demand. In both scenarios the results are the same. Oil prices soar along with gasoline and diesel and an eventual global inflation/recession/depression cycle of immense proportions will begin.

On Thursday CIBC World Markets released a report saying the price of oil is likely to hit $150 by 2010 and $225 by 2012 as supplies become increasingly tight. CIBC said the IEA's current oil production estimates overstate supply by about 9% since they wrongly count natural gas liquids, which are not viable for transportation fuel. 9% of 88 mbpd equals 7.9 million barrels per day that cannot be used for transportation fuels. Since the majority of our increasing demand growth is for transportation fuels this is a recipe for disaster.

The CIBC analyst, Jeff Rubin, also noted accelerating depletion rates in many of the world's largest and most mature fields. He estimates total production growth will barely exceed 1 mbpd between now and 2012. During that period oil demand is expected to grow between 1.6 and 1.8 mbpd. That means we are going to quickly be running short on oil. The falling demand in the U.S. because of higher prices, increasing biofuels and the shift to higher mileage cars will be offset by increases in emerging economies like India and China. India's Tata motors announced a $2500 car and that puts a car in the reach of tens of millions of Indian consumers. He also noted that car sales were up 60% in Russia in 2007, 30% in Brazil and 20% in China. Consumption is moving aggressively higher but production is not. Jeff said, "Whether we have already seen the peak in world oil production remains to be seen but it is increasingly clear that the outlook for oil supply signals a period of unprecedented scarcity. Despite the recent record jump in oil prices, those prices will continue to rise steadily over the next five years, almost doubling from current levels."

I reported last week that the Saudi Arabia ruler said they were not going to add to production over their 2009 target of 12.5 mbpd. The plan is to keep production steady as prices rise in order to secure the future of Saudi Arabia. Why bust their butt to ramp up production when they will get increasingly higher amounts for their oil as supplies in the rest of the world decline? I have suggested this would happen for several years. Why spend billions to pump your greatest asset out of the ground today to sell for $120 when you know you can get $200 a couple years from now? It does not make economic sense if your bank is already overflowing with billions from prior oil sales.

On April 23rd Goldman Sachs said the window for a seasonal spring decline in oil prices is closing fast. "Looking into the second half of this year, given the fundamental tightness, we believe the risks are substantially skewed to the upside."

Several prominent Russian oil officials and investors said last week that Russia's oil production has peaked. At 10 mbpd Russia is the worlds second largest producer. Leonid Fedun, the president of Lukoil, Russia's largest independent oil company, told the Financial Times that last years Russian production of just under 10 mbpd was the highest he would see in his lifetime. Fedun compared Russia to the North Sea and Mexico where large easy to reach fields have gone into steep decline and no amount of new discovery would ever make up for the steep depletion. Until just recently Russia was considered one of the most promising regions where new production growth might appear. Now those hopes have been dashed with revelations about depletion rates and rundown fields. Russia was never big on spending money on technology or implementing the latest methods of production. Drill, pump, cap has been the pattern.

I could literally go on with 100 other articles but the key is the common thread. The optimism about future production has faded and reality is slowly sinking into the projections. OPEC even admitted last week that there was little spare capacity and little hopes for producing new capacity from countries other than Saudi Arabia. Saudi oil minister Ali Naimi said, "limited capacity along the entire supply chain is the REAL source of current supply tightness and represents the greatest threat to ensuring adequate energy to fuel future growth." Shokri Ghanem, head of Libya's national oil corporation said there was little OPEC could do in the case of a shortfall. "Very little can be done by anyone, there is not enough spare capacity to help." William Ramsay, deputy director of the IEA warned, "Potential to expand production within OPEC: there is none, except in Saudi Arabia." Saudi has now said they would not increase production any more to preserve wealth for future generations.

Is the current price hikes the result of peak oil? I don't think so but they are the result of the fears over peak oil. We may not see the peak until 2010, my current target, but that does not mean demand cannot outstrip supply before we reach the peak in global production. That will have the same impact on prices as if we had begun to produce more oil. Insufficient supply to meet current demand will cause an explosion in prices to levels where many consumers simply will not be able to pay. What is that level? $6 gasoline in America, $10 in Europe? Many nations still subsidize gasoline at ridiculous prices like 25-50 cents per gallon to either stimulate their economy or to prevent economic collapse from high prices. They will not be able to continue this practice as the price of oil doubles. Civil unrest and economic disasters will be appearing worldwide. We are already seeing food riots in 33 countries because the price of rice and flour went up. What if gasoline doubled or tripled or worse because the countries government could no longer subsidize 50 cent gas? The world is about to become a very troubled place and there is little we can do about it. I predicted the food riots along with a significant reduction in population due to starvation once peak oil arrived. The signs are beginning to be seen and we are still a couple years from the real disaster.

Jim Brown

Sign of the times cartoon

June Crude Futures Chart - Daily

May Natural Gas Futures Chart - Daily

May Gasoline Futures Chart - RBOB Daily


Changes in Portfolio

New Energy Plays

None until oil cools

New Non-Energy Plays


Dropped Plays


New Watch List Plays Triggered
CLB $127.97 -2.03 Core Labs

Portfolio Listing & Top Picks

Top Picks

If you are looking to add another position these are my top picks for this week. The target prices listed would be the ideal entry points for these stocks today. There is no assurance any stock will ever return to these support levels and you will need to make your own decision about an entry point above these levels. I believe these stocks have the best potential this week. The list will change from week to week based on technicals, fundamentals, crude prices and market action. The list is not sorted in any particular order.


New Plays

Most Recent Plays

None this week.

Play Updates

Existing Plays

Energy Play Updates

USO $95.66 +1.87 - United States Oil Fund *** Short ***

Everything was going so well up until 4:AM Friday morning. Crude was $114.51 and falling. The Iran news broke and we saw a $5 spike over the next several hours. I think the Iran news will have faded by Monday but the U.K. Forties pipeline shutdown may continue to support prices.

I considered closing the play or putting a stop on it but our remaining premium is only 75 cents. For that price I will play the correction lottery and see if we get lucky. Use your own judgment on an exit.

Remember, gasoline, heating oil and natural gas futures expired on Friday and that could have a negative impact to crude futures next week.

Upside trigger: $90.00 Hit 4/15

Position: May $87 PUT UNA-QI @ $2.70


FLS $111.51 -2.21 - Flowserve

There was no news on Flowserve this week but be aware that earnings are on the 29th.

Breakout trigger: $110 Hit 4/16

Position: OCT $120 Call FLS-JD @ $10.40


UPL $86.35 +1.34 - Ultra Petroleum

Traders bought the dip in UPL on Thursday bringing it back into positive territory for the week. There was no specific UPL news.

The reason UPL has been rising is the new cross country pipeline to their property in Utah. Once completed they will be able to sell their gas for more money with access to the eastern markets. Ultra is on a capex program to spend $755 million in 2008 to boost production by 18-22%. They pln to boost production another 25-30% in 2009 over 2008 levels. 2008 estimates are for 135-140 BCF. They produced 117 BCF in 2007. 2009 estimates are for 170-175 BCF. 2010 estimates are for 200-205 BCF. That would be nearly double their 2007 production.

Breakout trigger: $83 Hit 4/14

Position: 2009 $90 LEAP Call OZH-AR @ $9.40


SPWR $86.29 -3.04 - SunPower *** Stop Loss $80 ***

SPWR is holding on support at $85 on no news. SPWR is the technology leader of the group with a 22% efficiency rating in the lab and 19.3% in commercial sales. Sunlight conversion efficiency is the holy grail of solar.

Cypress, which owns 56% of SPWR common stock and 90% of the voting stock, received a ruling from the IRS that would allow CY to spin off SPWR before Nov-09.

Breakout trigger: $66 (hit 3/24)

LEAP Call Spread
Long 2010 $80 LEAP Call LMO-AP @ $20.00
Shrt 2010 $130 LEAP Call LMO-AW @ $8.70


CY 28.34 +0.26 - Cypress Semi *** Stop Loss $21.50 ***

No news and no decline. Still holding near its 3-month highs.

Cypress, which owns 56% of SPWR common stock and 90% of the voting stock, received a ruling from the IRS that would allow CY to spin off SPWR before Nov-09.

Breakout trigger: $21.50 (hit 3/24)

Position 2010 $25 LEAP Call WSY-AE @ $4.90


MDR - $59.90 -.45 McDermott Intl ** Stop Loss $55 **

Thursday's opening drop was erased and MDR moved back to near its recent highs. No news and no change.

Breakout trigger: $51.00 (hit 3/24)

LEAP Call Spread
Long 2009 $55 LEAP Call OYZ-AK @ $8.28
Shrt 2009 $75 LEAP Call OYZ-AO @ $3.10


TS $52.08 -2.22 - Tenaris *** Stop Loss $49 ***

A reader emailed me on Monday asking if we should take profits on the gap open to just over $56. I replied that I expected TS to continue higher over the coming months and that was why we had no exit target in the portfolio. Then the Argentinean Economic Minister resigned and the Argentinean MERVAL index imploded. It would be the equivalent of Bernanke or Paulson resigning. Can I have that email back please? Hindsight is always 20:20 and while it would have been nice to exit knowing what we know now I still believe the demand for pipe in the energy sector is only going to get stronger.

Breakdown trigger: $46.00 hit 3/19

Position: SEP $50 Call TSW-IJ @ $3.40


HP $55.84 -.69 Helmerich & Payne *** Stop Loss $51 ***

Even bulletproof stocks can still trip. HP finally showed some weakness with a sharp drop on Wednesday. That drop was almost completely erased by Friday's close. Rig rates are still rising and the supply remains tight despite new rigs coming to market. HP's rigs are bought well in advance of their completion.

*** Earnings are Thursday May 1st ***

Earnings: Jan-31st $1.02

Position: Jan 2009 $35 LEAP Call ZQA-AG @ $4.50

Insurance put:
Position: Nov $30 HP-WF. @ .50, expired

Non-Energy Positions

EBAY $31.30 -0.41 - Ebay Inc *** Earnings Short ***

EBAY has not declined materially but it had help from the GOOG/AMZN earnings. Google is looking like it might roll over from its post earnings spike. If the rest of the net stocks start to follow Google down we might get our wish. EBAY is only $1.28 above our strike price and a $2 move would make us profitable. Keep the faith!

Entry 4/14 @ 30.87

Position: May $30 PUT XBA-QF @ $1.10

Covered LEAP Calls

AAPL $169.73 +8.69 Apple Inc *** Covered LEAP Call ***

Strong earnings and new 3-month high at $170. No change.

Long: AAPL @ open of $177.52 (Jan-14th open)
Short: 2009 $150 LEAP Call VAA-AW @ $20.80
Breakeven: AAPL @ $136.12

Position changes:
Closed $200 LEAP Short @ $9.40 ($30.00 - 9.40 = gain +20.60)
Replaced with $150 LEAP short @ $20.80
AAPL cost basis $177.52 - $41.40 (20.60 + 20.80) = 136.12
Breakeven: AAPL @ $136.12


RIMM $120.04 -3.18 Research in Motion

Despite a nearly $10 drop from Monday's highs RIMM is holding its longer-term gains rather well. There was news on Friday that the new 3G BlackBerry Meteor availability was pushed back from June to August. No change, orders are expected to be huge.

If we continue holding the position until January and let it get called away your profit will be $34.80 when the stock is called away for $110.

Alert entry 11/12 @ $102.60

Covered LEAP Call:

LONG RIMM @ $102.60 (cost $102.60 -9.10 $150 LEAP = 93.50)
SHORT 2009 $110 LEAP Call VHO-AB @ $18.30 on 1/14/08

Closed: 1/14
SHORT 2009 $150 LEAP Call XTB-AJ @ $18.50, close $9.40 +9.10

Leaps Trader Watch List

Dropped Entries


New Watch List Entries
Petrobras - Added breakout trigger
RIG Transocean
NE Noble Corp
NOV National Oilwell Varco

I am really hesitant to add a bunch of plays with oil at $120. We saw crude decline to nearly $114 on Thursday night and that would have created a monster drop in stock prices. This shows that sellers are out there and we need to be patient.

Current Watch List

PBR - Petrobras

We have had the most horrible luck on this company. As it was declining towards $110 last week some idiot in the NPA in Brazil said they had discovered a 33 billion barrel deposit. Petrobras denied it and the official may be charged with a crime for spreading disinformation. The market still has 33 billion imprinted on their foreheads and we may never see a dip here. I changed the triggers and the strikes to compensate somewhat but I am not going to chase it.

Company Info:

Petroleo Brasileiro SA - Petrobras (Petrobras) is a Brazil-based holding company engaged in the exploration, production, refinement and distribution of oil and gas. The Company is involved in four business areas: Exploration and Production, Downstream, Gas & Energy and International. Petrobras has 109 production platforms and 15 refineries. It operates 31,089 kilometers of pipelines. The Company has various subsidiaries: Petrobras Quimica SA - Petroquisa, which is engaged in the production, commercialization, distribution, import and export of chemical products; Petrobras Distribuidora SA - BR, which is involved in the distribution and commercialization of oil products and natural gas, and Petrobras Netherlands BV - PNBV, which is active in the purchase, sale and rent of equipment and platforms for the production of oil and gas. Petrobras operates in Brazil, Argentina, Mexico, Portugal, the United States, Peru and Turkey, among others.

Breakout trigger: $125.50

Buy 2010 $150 LEAP Call YMO-AV

Breakdown trigger: $115

Buy 2010 $120 LEAP Call YMO-AD
Sell 2010 $180 LEAP Call YMO-AX


USO - U.S. Oil Fund

This is our Hail Mary play. If we ever get a real correction hopefully we can get long.

Breakdown trigger: $87 *** New trigger ***

Buy 2009 $90 LEAP Call OLL-AL *** New Strike ***
Sell 2009 $120 LEAP Call XNF-AP *** New Strike ***


MOS - Mosaic

We missed our breakdown entry by $1.21 at $120 before MOS rebounded +$10. I am hesitant to add a breakout position because the options are so expensive. Let's give it another week.

Company Info:

The Mosaic Company (Mosaic) is a producer of phosphate and potash combined, as well as nitrogen and animal feed ingredients. The Company operates its business through four business segments: phosphates, potash, offshore and nitrogen. The Phosphates segment operates mines and concentrates plants in Florida that produce phosphate fertilizer and feed phosphate, and concentrates plants in Louisiana that produce phosphate fertilizer. The Potash segment mines ad processes potash in Canada and the United States and sells potash in North America and internationally. The Offshore segment produces and markets fertilizer products and provides other ancillary services to wholesalers, cooperatives, independent retailers, and farmers in South America and the Asia-Pacific regions. The Nitrogen segment consists of its equity investment in Saskferco and Mosaics nitrogen sales and distribution activities.

Breakdown trigger: $120

Buy 2010 $140 LEAP Call LXW-AX
Sell 2010 $240 LEAP Call KCA-AH



Based on the recent announcements by BP it may be time to take another run at this stock. When Thunderhorse comes online in Q3 it should get a lot of press due to the high volume of oil they expect to produce. Maybe BP's troubles are over.

*** CAUTION - Earnings are April 29th ***

Company Info:

BP p.l.c. (BP) is a holding company. The Company three business segments: Exploration and Production, Refining and Marketing and Gas, Power and Renewables. Exploration and Productions activities include oil and natural gas exploration, development and production (upstream activities), together with related pipeline, transportation and processing activities (midstream activities). The activities of Refining and Marketing include the supply and trading, refining, marketing and transportation of crude oil, petroleum and chemicals products. Gas, Power and Renewables activities included marketing and trading of gas and power, marketing of liquefied natural gas (LNG), natural gas liquids (NGLs) and low-carbon power generation through its Alternative Energy business. During the year ended December 31, 2007, BP acquired Chevrons Netherlands manufacturing company, Texaco Raffiniderij Pernis B.V. In April 2008, BP registered in Russia its subsidiary BP Exploration Services.

Breakdown trigger: $65.

Buy 2010 $70 LEAP Call WAO-AN


COP - ConocoPhillips

Earnings are April 24th. Maybe we can get a double dip of a drop in crude futures and earnings from ConocoPhillips.

Company Info:

ConocoPhillips is an international, integrated energy company. It has six operating segments. Exploration and Production segment explores for, produces and markets crude oil, natural gas and natural gas liquids. Midstream segment gathers, processes and markets natural gas, and fractionates and markets natural gas liquids, primarily in the United States and Trinidad. Refining and Marketing segment purchases, refines, markets and transports crude oil and petroleum products. LUKOIL Investment segment consists of its equity investment in the ordinary shares of OAO LUKOIL. The Chemicals segment manufactures and markets petrochemicals and plastics on a worldwide basis. Emerging Businesses segment includes the development of new technologies and businesses outside the Companys normal scope of operations. In October 2007, American Electric Power Company, Inc. sold its 50% interest in the Sweeny Cogeneration plant in Texas to ConocoPhillips.

Breakdown trigger: $80

BUY 2010 $90 LEAP Call YRO-AR


NE - Noble Corp

Noble recently won a $4 billion contract to drill for Petrobras off the coast of Brazil. This is a monster payday and just one area of exploration for Noble.

Company Info:

Noble Corporation (Noble) is engaged in contract drilling services worldwide. It performs contract drilling services with its fleet of 62 offshore drilling units located worldwide. This fleet consists of 13 semi-submersibles, three drillships, 43 jackups and three submersibles. The fleet count includes two F&G JU-2000E jackups and three deepwater dynamically positioned semisubmersibles under construction. As of December 31, 2007, approximately 85% of its fleet was deployed internationally. Its other operations include labor contract drilling services, and through November 2007, engineering and consulting services. Its operations are conducted principally in the Middle East, India, United States, Gulf of Mexico, Mexico, the North Sea, Brazil, West Africa and Canada. During the year ended December 31, 2007, Noble completed the rationalization of its technology services division with the sale of the rotary steerable system assets of its Noble Downhole Technology Ltd. subsidiary.

Breakout trigger: $61.00

Buy 2010 $70 LEAP Call YVJ-AN

Breakdown trigger $56.00

Buy 2010 $70 LEAP Call YVJ-AN


RIG - Transocean

RIG has declined slightly from its highs at $160 early in the week. If we get a correction in oil prices we could see a touch of $145. RIG is the premier deep water driller and there is no scenario where they don't continue to move higher. We just need to catch them on a dip if possible.

Company Info:

Transocean Inc. (Transocean) is an international provider of offshore contract drilling services for oil and gas wells. As of February 20, 2008, the Company owned, had partial ownership interests in or operated 139 mobile offshore drilling units. Its fleet included 39 high-specification floaters (ultra-deepwater, deepwater and harsh environment semisubmersibles, and drillships), 29 midwater floaters, 10 high-specification jackups, 57 standard jackups and four other rigs. As of February 20, 2008, the Company also has eight ultra-deepwater floaters contracted for or under construction. The Companys primary business is to contract these drilling rigs, related equipment and work crews primarily on a day rate basis to drill oil and gas wells. In November 2007, the Company completed its merger transaction with GlobalSantaFe Corporation (GlobalSantaFe).

Breakout trigger: $157.50
Breakdown trigger: $150

Buy 2010 $170 LEAP Call YDR-AN
Sell 2010 $230 LEAP Call YDR-AW


NOV - National Oilwell Varco

NOV just completed the acquisition of Grant Prideco on April 21st. This was a major acquisition for them and should be very accretive very quickly. They seem to have stagnated at $75 as the acquisition completed and if they enter a post acquisition decline as is common to most companies it could be our entry point.

Company Info:

National Oilwell Varco, Inc. is a provider of equipment and components used in oil and gas drilling and production operations, oilfield services, and supply chain integration services to the upstream oil and gas industry. It has three segments: Rig Technology, Petroleum Services & Supplies, and Distribution Services. The Rig Technology segment designs, manufactures, sells and services systems for the drilling, completion and servicing of oil and gas wells. The Petroleum Services & Supplies segment provides consumable goods and services used to drill, complete, remediate and workover oil and gas wells, service pipelines, flowlines and other oilfield tubular goods. The Distribution Services segment provides maintenance, repair and operating supplies, and spare parts to drill site and production locations worldwide. In July 2007, NOV acquired, through a wholly owned subsidiary, a 76% stake in Sara Services and Engineers Private Limited. In April 2008, it acquired Grant Prideco, Inc.

Breakout trigger: $76

Buy NOV $90 Call NON-KR

Breakdown trigger: $67

Buy NOV $80 Call NOV-KP


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