Option Investor

Weekly Newsletter, Saturday, 09/13/2008

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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

Twilight Zone

Ladies and gentlemen you have entered a place where normal laws of supply and demand no longer apply. A place where hurricanes can cripple three weeks of crude production in the gulf and shutdown over 20% of U.S. refining capacity without any rise in crude prices. This is a place where gasoline inventories are at 8-year lows and crude supplies could drop by more than 20 million barrels next week and yet oil prices dropped below $100 on Friday. You have entered the Twilight Zone.

I may not be Rod but this is definitely the Twilight Zone. Crude prices actually fell on Friday while Texas Governor Rick Perry was predicting $100 billion in damages on refinery row in Houston. "If we get the 20 foot storm surge we are expecting it could take 1-3 months before all the refineries are operating again. There are 13 refineries in the Houston area representing over four million barrels of refining capacity and all were shutdown well before hurricane Ike made landfall Friday night.

Ike was a monster 600-mile wide storm with an almost unheard of eye of 49 miles across. It came ashore Friday night with winds of 110 mph, only 1 mph below category 3 levels. The storm was so large experts said it could take 12 hours to pass over Houston.

The reason the price of oil was not rising is actually a refinery problem. Refinery utilization last week was only 78% because of the shutdown for Gustav. This week over 20% of U.S. refinery capacity was shutdown before Thursday to prepare for Ike. If Ike really did knock out all those refineries in Houston there would immediately be a surplus of crude even with production in the gulf shutdown. No refiners, no refined products and no consumption of crude. Gasoline, heating oil and jet fuel will rise as supplies dwindle but crude prices should sink. The U.S. only has 20 days of supply in gasoline and that includes the gasoline in the pipelines that cannot be removed. The only reason crude prices should rise next week is severe damage to the offshore wells and production platforms. Since Ike moved through the oil patch as a category 2 storm most should have survived intact.

Saturday Update: I wrote the above on Friday night and as of late Saturday afternoon it appears the damage was far less severe than expected. Refineries are already restarting and oil companies are sending the first wave of workers back to the production platforms in the gulf. There will probably be some lingering refinery problems until power is restored but I could not find any news updates about major damage to any oil facility.

Refiners on the west coast stand to benefit because they won't be harmed and can run at 100% capacity to meet the shortfall. Holly (HOC) and Tesoro (TSO) are prime examples. Of course the bounce will be short lived. Valero got a bounce because of its wide footprint only three of its refineries were in harms way.

Shut In Production In the Gulf

Despite flooding in Louisiana and several levees being topped by the surge the Louisiana Offshore Oil Port or LOOP should be back in operation quickly. Companies should begin damage assessment and restart of production platforms in the gulf by late Sunday. There are no other storms on the horizon to cause problems. Tropical storm Josephine dissipated last week and the remnants are generating rain a couple hundred miles northeast of the Bahamas.

The Minerals Management Service said personnel had been evacuated from 453 production facilities, or 63% of the 717 manned platforms in the gulf. 81 rigs were evacuated or roughly 67% of all gulf rigs. Shell reported that its Perdido spar escaped the wrath of Ike even though it was a direct hit in the deepwater gulf.

Hugo Chavez is stirring up trouble again. A day after two Russian Backfire bombers landed in Venezuela Chavez expelled the U.S. ambassador and threatened to halt exports to the U.S. in a show of support with Bolivia. Bolivia expelled its top U.S. envoy two days earlier and accused the U.S. of backing opposition in Bolivia. Chavez needs the U.S. and Venezuela is the 4th largest supplier of oil to America. If we cut him off he would dry up and blow away. He is never going to cut us off or he would be out of money inside a week. His threats are used to get sympathy and support from his people and to raise oil prices. According to the IEA his production is running 150,000 bpd under his quota. He is taking all the cash flow from the oil industry and not leaving them enough to increase production. As one analyst put it, "He is taking the cows milk but not feeding it enough hay to survive." Let's hope he drowns on that milk.

It is that time of the month again. The October crude futures cease trading on Monday 9/22. You can expect that to add to the volatility next week. I am expecting the price of oil to fall next week simply because every event including a cut by OPEC has been ignored. You may remember the monster dive of -$8 the futures took on the Monday after Gustav. There still seems to be more sellers than buyers and those waiting to sell on hopes crude would spike on massive damage may be disappointed and exit quickly ahead of expiration.

Jim Brown

If you have registered for the ASPO Peak Oil conference and have not received a personal email from me with conference notes please send me an email. There is still time to register and join the crowd. Go here to register: http://www.aspo-usa.org/aspousa4/

October Crude Futures Chart - Daily

October Natural Gas Futures Chart - Daily

October Gasoline Futures Chart - RBOB Daily


Changes in Portfolio

New Energy Plays

None - see watch list

New Non-Energy Plays

None - see watch list

Dropped Plays
APC Anadarko Petroleum *** Stopped ***
MOS Mosaic *** Stopped ***
AAPL Apple Inc *** Stopped ***

New Watch List Plays Triggered
VLO $35.87 Valero
USO $81.49 US Oil Fund

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.

I strongly urge readers to be patient on new entries. We could see oil in the mid $90s before the volatility is over.


New Plays

Most Recent Plays

New Watch List Plays Triggered

VLO $35.87 - Valero

The Tuesday gap down open finally trigger the entry in Valero at $32 on its way to $29.32. Fortunately Valero figured prominently in the end of week refiner rally and closed right at a new two month high. Valero had to shut down three refineries in the Houston area totaling 700,000 bpd of capacity but they have 14 other refineries not in the hurricane's path to make up the difference. Falling oil prices and rising gasoline prices should continue to benefit Valero. The initial stop loss will be $29.

Company Info:

Valero Energy Corporation (Valero) owns and operates 17 refineries located in the United States, Canada and Aruba that produce conventional gasolines, distillates, jet fuel, asphalt, petrochemicals, lubricants and other refined products. The Companys principal products include conventional and California Air Resources Board (CARB) gasolines, reformulated gasoline blendstock for oxygenate blending (RBOB), ultra-low-sulfur diesel, and oxygenates and other gasoline blendstocks. Valero also produces a substantial slate of middle distillates, jet fuel, and petrochemicals, in addition to lube oils and asphalt. 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 also sells refined products through a network of approximately 5,800 retail and wholesale branded outlets. Effective July 1, 2007, the Company completed the sale of the Lima, Ohio refinery to Husky Energy Inc.

Breakdown trigger: $32, hit 9/09

Position: 2010 $40 LEAP Call YPY-AH @ $4.50


USO $81.49 - US Oil Fund

After being on the watch list for six weeks the USO finally declined enough to hit our $82 entry point. With strong support at $80 I was confident last week that we would see a bounce. Given the price action in crude last week I am no longer confident. I believe crude will pause at $98 and that should equate to $80 on the USO. Hopefully the aftermath of hurricane Ike will not be detrimental to oil prices and we will see a rebound from support. If $98 crude breaks we could see a serious drop before OPEC could get its propaganda machine fired up. There is major support on the USO at $70 but we will be out well before that happens. Initial stop loss is $78.50.

Company Info:

United States Oil Fund, LP (USOF) is a commodity pool that issues limited partnership interests or units that may be purchased and sold on the American Stock Exchange (the AMEX). The Company invests in futures contracts for light, sweet crude oil and other types of crude oil, heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the New York Mercantile Exchange (NYMEX), International Currency Exchange (ICE) Futures or other United States and foreign exchanges (collectively, Oil Futures Contracts). It holds interests in other oil-related investments such as cash-settled options on Oil Futures Contracts, forward oil contracts, and oil-based over-the-counter transactions. As of December 31, 2007, USOF held 4,754 Oil Futures Contracts traded on the NYMEX and 300 Oil Futures Contracts traded on the ICE Futures. The Company operates under full management control of its sole General Partner, Victoria Bay Asset Management, LLC (the General Partner).

I am not using LEAPS because I view this as a short-term trade.

Breakdown trigger: $82, hit 9/10

Position: JAN $90 Call UNA-AL @ $5.30


Play Updates

Existing Plays

HP $47.97 -$1.36 - Helmerich & Payne

Excellent bounce from support at $43 and just above our stop at $42. HP continues to get new build rig orders for horizontal rigs with Encana ordering 5 new rigs on 3-year contracts. Huge shale gas finds are adding to the backlogs from all rig builders.

Breakdown trigger: $52, hit 9/02

Position: 2010 $60 LEAP Call LQB-AL @ $9.10


PCP $103.05 +4.91 - Precision Cast Parts

That is more like it! PCP rebounded strongly from the prior week's decline and is showing no weakness. PCP will be presenting at the Bank America conference on the 16th and I suspect it will be positive.

Breakout trigger: $105, Hit 9/02

Position: Jan 2010 $120 LEAP Call YAM-AD @ $14.90


MOS $91.95 -$2.57 - Mosaic *** Stopped ***

Mosaic only lost -2.57 for the week but in the middle of the week was down $22 from the Monday high. We were stopped on the dip through $83. This market is simply too volatile to play until a trend emerges.

Breakdown trigger: $95, hit 9/04

Jan 2009 $120 LEAP Call LXW-AD @ $20.20, exit $18.80 9/08


HES $92.28 +0.84 - Hess Corp

Hess skillfully evaded our stop at $78 and rebounded $12 to close the week almost exactly where it started.

Breakdown trigger: $95, hit 9/03, net debit $4.40

Long 2010 $100 LEAP Call WHS-AT @ $20.70
Short 2010 $90 LEAP Put WHS-MR @ $16.30


FTI $50.18 +1.30 - FMC Technologies

FTI rebounded +$7 from the Tuesday low to post a gain for the week. They should benefit from any repair work in the gulf.

Entry $48.88 9/07

Position: APR $55 Call FTI-DK @ $5.60


APC $56.89 -1.39 - Anadarko Petroleum *** Stopped ***

Anadarko lost $5 on the Tuesday gap lower and blew through our stop on no news. Evidently the $5 billion buyback news was quickly forgotten.

Stop at $55.

Breakdown trigger: $55, hit 8/04

Position: 2010 $70 LEAP Call YPC-AN @ $7.60, exit 4.86 9/09

Non-Energy Positions

XHB $21.26 +1.37 - S&P Homebuilder SPDR

The Fannie and Freddie takeover produced a strong opening gap on Monday and filled us near the high for the week. Fortunately the excitement about homebuilders held up for the rest of the week.

Entered: $21.80 (9/08)

Position: 2010 $25 LEAP Call KHG-AY @ $3.70


GS $154.21 -9.34 - Goldman Sachs - Combination play

Bank analyst Meredith Whitney started the week off wrong with a downgrade on GS earnings expectations and it just got worse from there. I think there were six downgrades for the week with every day just another chapter in the nightmare. The gap open on Monday had us entering at $171 and the downgrades knocked off $17 from that gap. Earnings are Tuesday and GS can go from zero to hero with a good report. Initial stop is now $148.

Entered at open: $171 9/08

Long 2010 $200 LEAP Call WSD-AT @ 21.45, net credit 0.55
Shrt 2010 $150 LEAP Put WSD-MG @ 22.00


AAPL $148.98 -11.24 Apple Computer *** Stopped ***

Thank you Apple. The new product event was lackluster and the stock was crushed.

Breakdown trigger: $160, Hit 9/05

Position: Jan 2009 $190 Call APV-AR @ $7.80, exit 4.10 9/11

Leaps Trader Watch List

I hesitated to add more entries to the watch list with expectations that oil prices will fall next week. However, we are getting closer to the calendar period where we could see a market bottom and a rebound into year-end. I don't want to be caught flat-footed and wishing we had bought the dip. I tried to add companies that are not directly impacted by the fluctuations in oil prices.

Dropped Entries


New Watch List Entries
NE Noble Corp
NOV National Oilwell
PBR Petrobras
FTK Flotek
MDR McDermott
JEC Jacobs Engineering
FLR Fluor

Current Watch List

NOV - National Oilwell Varco

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.


Breakdown trigger: $53

Buy FEB $60 Call NOV-BL

Breakout trigger: $65

Buy FEB $70 Call NOV-BN


NE - Noble Corp

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.

Breakdown trigger: $44

Buy 2010 $50 LEAP Call YVJ-AJ

Breakout trigger: $54

Buy 2010 $60 LEAP Call YVJ-AL


PBR - Petrobras

I am still leery of Petrobras because of possible government intervention but they just discovered another 5-8 billion barrel field in early September. Estimates on costs to build out the Tupi field range from $600 billion to $1.2 trillion. Brazil does not have that kind of money and may be deciding it is best to leave Petrobras intact and able to raise the money through the market.

Company Info:

Petroleo Brasileiro SA - Petrobras (Petrobras) is a Brazil-based holding company is engaged in the exploration, exploitation and production of oil from reservoir wells, shale and other rocks, and in the refining, processing, trade and transport of oil and oil products, natural gas and other fluid hydrocarbons, in addition to other energy related activities. Petrobras has 109 production platforms and 15 refineries. It operates 31,089 kilometers of pipelines. The Company has various subsidiaries: 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.

Breakdown trigger: $40

Buy 2010 $50 LEAP Call YMO-AJ

Breakout trigger: $49

Buy 2010 $60 LEAP Call YMO-AL


FTK - Flotek

Company Info:

Flotek Industries, Inc. is a global supplier of drilling and production related products and services to the energy and mining industries. Its core focus is oilfield specialty chemicals and logistics, downhole drilling tools and downhole production tools. Flotek offers its products primarily through its sales organizations, as well as through independent distributors and agents. The customers for its products and services include oil and natural gas companies, independent oil and natural gas companies, pressure pumping service companies and state-owned national oil companies. Five customers accounted for approximately 34% of its consolidated revenue during the year ended December 31, 2007. The Company's reportable segments are Chemical and Logistics, Drilling Products and Artificial Lift. All three segments market products domestically and internationally.

Breakdown trigger: $11

Buy 2010 $15 LEAP Call YVB-AC

Breakout trigger: $13.50

Buy 2010 $15 LEAP Call YVB-AC


MDR - McDermott Intl

Company Info:

McDermott International, Inc. is an engineering and construction company with specialty manufacturing and service capabilities and is the parent company of the McDermott group of companies, including J. Ray McDermott, S.A. (JRMSA) and The Babcock & Wilcox Company (B&W). The Company operates in three business segments: Offshore Oil and Gas Construction, Government Operations and Power Generation Systems. On July 27, 2007, the Company acquired Secunda International Limited. On May 1, 2007, it acquired Marine Mechanical Corporation.

Breakdown trigger: $27

Buy 2010 $35 LEAP Call YAE-AG

Breakout trigger: $38

Buy 2010 $50 LEAP Call YAE-AJ


JEC - Jacobs Engineering

Company Info:

Jacobs Engineering Group Inc. (Jacobs) is a professional services firm in the United States. The Companys business focuses on providing a range of technical, professional and construction services to industrial, commercial, and governmental clients around the world. Jacobs provides four categories of services: Project Services (which include engineering, design, architectural, and similar services); Process, Scientific and Systems Consulting services (which includes services performed in connection with a variety of scientific testing, analysis and consulting activities); Construction services (which encompasses traditional field construction services, as well as modular construction activities, and includes direct-hire construction and construction management services), and Operations and Maintenance services (which includes services performed in connection with operating large, complex facilities on behalf of clients, as well as services involving process plant maintenance).

Breakdown trigger: $60

Buy 2010 $80 LEAP Call WEU-AP (No $70 LEAP listed)

Breakout trigger: $68

Buy 2010 $80 LEAP Call WEU-AP


FLR - Fluor

Company Info:

Fluor Corporation is a holding company that, through its subsidiaries, provides engineering, procurement and construction management (EPCM) and project management services. Fluor serves a number of industries worldwide, including oil and gas, chemical and petrochemicals, transportation, mining and metals, power, life sciences and manufacturing. Fluor is also a primary service provider to the United States Federal Government. It performs operations and maintenance activities for major industrial clients, and also operates and maintains their equipment fleet. The Company is aligned into five principal operating segments: Oil and Gas, Industrial and Infrastructure, Government, Global Services and Power. Fluor Constructors International, Inc., which is organized and operates separately from its business segments, provides unionized management, construction and management services in the United States and Canada, both independently and as a subcontractor on projects to its segments

Breakdown trigger: $60

Buy 2010 $70 LEAP Call LLF-AZ

Breakout trigger: $72

Buy 2010 $80 LEAP Call LLF-AP


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