Wrap – Week Ended 12/07/07

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Key Takeaways (match with big red numbers above).

1) Not a bad week for energy....again. Last week the energy sectors as defined by XOI (oily), XNG (gassy), and OIH (service) were flat in a down market as both oil and gas fell hard (down 10% and 9% respectively). This week oil apparently found a bottom after OPEC held production "officially" steady and natural gas, also waning of late, held up reasonably well after the EIA reported a bigger than expected draw from storage. The stocks began to move higher. Also this week the broad decided that the White House/Treasury/Federal Reserve plan to save a million or so home owners from themselves (and more importantly to keep them from foreclosure and further whacking the financials) was a rally inspiring event. I thought Sane's comment about that on Thursday could not be improved upon:

We shouldn’t be freezing anything. Am I going to get a rate discount on my fixed mortgage?….. no. I hate to say it, but when you go and get an adjustable rate mortgage and fail to understand what adjustable means, well then you deserve what you get. I know someone who is quaking in his boots about his ARM reseting. I asked him why he got an ARM and his reply was, “well it was the only way I could afford the house we wanted.” He bought more than he could afford, and now it is coming back to bite him in the ass. No pity here. LET THE MARKET CORRECT ITSELF.


2)  Crack spreads improved last week. Now before you say, "wow $31 cracks" let me point out my use of the word generic. Here generic means hypothetical which was too poly-syllabic to fit in the constraints of the column widths in the wrap table above. This crack spread is the 3-2-1 spread you would get using front month prices for NYMEX crude, heating oil, and reformulated gasoline. No one is getting a spread this high and only the % improvement should really be given notice here. Here are the regional cracks from the prior week which I will update on Tuesday (they should have improved slightly this past week):


3) Gas Price Metrics Were Mixed On The Week. While weather is the dominant factor driving prices other clues as to trader's liking for methane were a bit cloudier.

  • The CFTC showed an increase in shorts and an even larger increase in longs leading to a reduction in the net short position in NYMEX natural gas futures. This is an indication that traders are getting a bit less bearish as winter gets closer but also offers just a little less rally potential in the case of a cold snap/short cover event.
  • Rigs drilling for gas increased again and is now only 20 rigs from a 20 year high. Sounds bearish but remember that it takes the high rig count to get the level of storage we are at in the way (shale drilling) we have gotten here. Stop drilling, or even slow down for a couple of months and production growth will stall.
  • For a good run through on my latest thoughts on natural gas click here to go to Wednesday post.

Exited Two Trades This Week:

  • DO: Exited the December $120 Calls for $6.20, up 85% since Monday’s entry. Still hold the Dec $115 Calls.
  • RIG: Exited the December $130 Calls for average $6.05 (up 89% in 24 hours)…it jumped more than I would have possibly expected the day after the trade. I can always buy it back on the coming dip.

Entered a number of trades detailed on the subscriber holdings page including new positions in oil service, solar, and crude and product tanker stocks.

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13 Responses to “Wrap – Week Ended 12/07/07”

  1. 1
    dmharvey8 Says:

    Zman: New subscriber: What is your opinion of this article re flow of oil, etc for the short term?


    Oil’s Going to $70
    By Elliott H. Gue
    For the first time in more than a year, I’m a near-term bear on oil prices. I suspect that crude could fall to around $70 per barrel in the next three to four months, roughly a 30 percent correction from its recent highs. This move will be a correction of the long-term uptrend in crude, not the end of the bull market. This correction will mark a historic buying opportunity for both oil and oil-related stocks.

    I posted a comment and video clip on At These Levels (www.attheselevels.com) earlier this week that explains the rationale behind that short-term bearish take. To elaborate further, crude oil’s rise to near $100 a barrel has been widely reported in the print and television media; these outlets have offered myriad “explanations” for the rally. But the fact is that most of these explanations are totally and completely wrong.

    Many investors and pundits remain wedded to the idea that crude oil’s rise is some sort of speculative bubble or temporary spike. Therefore, explanations for the rally tend to center around minor, short-term factors rather than the explosively bullish longer-term supply and demand picture. One of the most-often mentioned explanations for oil’s rally is that it’s a function of speculative buying of oil futures. Fortunately, we can debunk that idea simply by looking at the Commitment of Traders (COT) Report released weekly by the Commodity Futures Trading Commission (CFTC).

    Basically, the COT breaks down futures traders into two groups: commercials and non-commercials. Commercials would be companies using futures to hedge their business risks. Examples might include a refiner looking to hedge against the potential for crude oil prices to rise or an oil producer using futures to lock in attractive prices for their production. Commercials aren’t really speculating on the futures market.


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    The non-commercials are traders. These would include hedge funds making a bet on the future direction of prices. Non-commercials are a decent gauge of sentiment. When these traders are heavily net long it can mean that there are few marginal buyers left to push prices higher. Sometimes, this can mark a short-term top.

    Typically, when the media states that high oil prices are a function of speculation, they’ll present a chart that looks like the one below.

    Source: Bloomberg

    This chart shows total non-commercial long commitments in the futures market. Obviously, this line is rising, meaning that more speculative traders are buying oil futures, betting on a rise in prices. This is often presented as a sign of excess speculation.

    But this is only half the story. Check out my chart below.

    Source: Bloomberg

    This chart shows total short commitments by non-commercial traders. These are speculators betting on a fall in oil prices. Note that this line is also rising. If we look at this chart in isolation, it might suggest that non-commercials are actually overly bearish oil prices.

    The fact is we have to consider both charts to get the complete picture. The fact is that traders have been getting more bullish on oil as the commodity has risen in the past 12 months. However, sentiment isn’t at all as bullish as my chart of long commitments suggests. The fact is that total open interest—long and short—has been rising this year. If we consider long-side interest as a percent of total open interest, the chimera of a speculative futures bubble in oil disappears.

    The reason for oil’s rally has to do with simple supply and demand. Inventories of oil and refined products in the developed countries have been falling during a time of year when they normally build. Meanwhile, demand for oil has remained firm despite relatively high prices. Check out the chart below.

    Source: International Energy Agency

    There are a few key points to note about this chart. The first is that I’ve labeled the third quarter of each year as a red bar.

    Note that at the end of the third quarter, OECD inventories of crude were considerably lower than a year ago and actually lower than in 2005. Therefore, across the OECD, the supply of crude is tighter than it has been at this time of year since 2004.

    Also note the typical change in OECD inventories between the second quarter and third quarter of each year. In a normal year, crude oil stocks actually rise between the end of the second quarter and the end of the third quarter. This corresponds to the end of the summer driving season in the Northern Hemisphere.

    Note, however, that there was actually a fall in OECD crude oil inventories in the third quarter this year. Stocks of crude fell approximately 360,000 barrels per day in the fourth quarter, a counter-seasonal crude oil drawdown. That continued into October; early International Energy Agency (IEA) estimates show a further 21-million-barrel draw in the month for OECD countries.

    Although US oil inventories remain above average for this time of year, inventories did decline in the third quarter. That’s certainly not the normal seasonal pattern. And we can’t focus solely on the US; oil inventories in Japan, for example, currently stand at their lowest level in at least 20 years.


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    But this picture is about to change. The reason is that until very recently, OPEC has remained disciplined and hasn’t been sending as much oil to the West as it normally would at this time of the year. This is evident from the fact that tanker rates have remained depressed at a time of year when they normally rise. Those ships are sitting idle because OPEC isn’t shipping oil. With OPEC not shipping and oil production from non-OPEC countries weaker-than-expected, global oil inventories fell sharply.

    But tanker rates are now spiking higher to the highest levels since mid-2006. That suggests that OPEC is now shipping oil west. As this oil hits the inventory numbers sometime in the first quarter of next year, the supply picture will look far looser.

    Keep in mind this is a short-term phenomenon. Longer term, demand from the developing world will continue to rise. And supplies will continue to be challenged. Global oil supplies simply aren’t keeping pace with growth in demand.

    For a more complete look at the current outlook for oil and tankers along with some of my favorite plays on these trends, check out my blog entry and video clip on At These Levels (www.attheselevels.com).

  2. 2
    zman Says:

    Thanks DM, will look into and get back to you.

  3. 3
    TTupp Says:

    z- vlcc day rates as of the 7th were $142,181 not $126,375 . had a 15k bump on friday.

  4. 4
    TTupp Says:

    has anyine see what happens to FRO when the stock goes ex-dividend? drop…… ex-div date the stock falls by the same amount as the amount of the dividend. bri- hope they taught you thins in your intro to capital markets class….

    Mr Bill, do you now when q4 dividend report date is? not to mention ex-div date- d-day.. from what i can see of the mess of div distributions and announcements march looks like the next likely intervention.

    am i fretting for no reason? ive never played options on yield rich equities…. doses the option get punished for the dividend payout on ex-day?

  5. 5
    zman Says:

    T: that was rates to Japan according to intertanko.

    But I’m using a more conservative blend of east and west rates (which were down a touch on the week) at
    click newsletter…the week saw lower activity of bookings so I didn’t trust using that further spike up. Rates were at $60k per day just a couple of weeks ago so it really doesn’t matter if they were flat on the week.

  6. 6
    zman Says:

    DM – I don’t disagree with the thesis but think $70 may be a bit of a stretch.

    I’ve been calling for tightness in 4Q and 1Q. Based on current levels of supply (roughly flat Y0Y) on a quarter to date average and expected higher consumption (nearly 2 mm bopd higher in 4Q07 vs 4Q06 and a projected (EIA and IEA) bump YoY of similar size in 1Q I expect stocks to fall to 5% or a little more below the 5 year average during 1Q08.

    At present we are in line with 5 year average and 10% BELOW year ago levels. As the author says, demand remains high despite higher prices.

    I don’t talk often about CFTC as it relates to oil because the contract volume there vs global activity has never shown a causal relationship. Oil is global and natural gas is local so CFTC analysis seems to show more meaningful relationship to price (on a net long/net short basis) for gas than it does for oil. Also, with other exchanges like ICE becoming more active in WTI contracts on a daily basis the relationship grows cooler still. I do agree that the high interest and peak levels of longs would indicate a top (in gas) but for oil, I think it is less meaningful.

    The author is long term bullish on oil prices. I agree. He likes the tankers. I agree. He likes the tankers more than traditional oil plays. I think not but his definition of traditional oil plays may be XOM where as mine would be something like APA.

    A fall to $70 though? The pendulum often swings too far and $70 is possible but it seems unlikely. A year ago, the current January contract was trading at $68 . At that time crude stocks in the U.S. were 12% ABOVE the 5 yr average then and 7% ABOVE the 3 year average.

    At present we are in line with the 5 year average, 4% BELOW the 3 year average and 10% BELOW the year ago level.

    and OPEC was producing more then than it is now.

    I agree with the author that fundies are a good part of what’s driven crude higher but disagree when he completely writes off (or at least that’s how I read it) the part of the speculators. They are definitely in there. Right now, they are riding the razor’s edge between getting long and getting “further” out. If we had gotten a 8 million barrel draw and no OPEC boost three weeks ago oil would have surged to $105. But the specs are busy worrying about what the other specs are doing and so seemingly bullish news falls to prompt a rally and so reporters cite economic concerns for the fall in crude (despite the fact that the market seems to be happier now than before).

    $86 is pretty key technically and the author could be right about the a move lower if they trade through this level as technicals take hold and reason goes out the window. At that juncture you could see $80….which would be a big buy point. The OECD stocks are also low (as he points out) and only a recession WITH NEGATIVE JOB GROWTH will seriously impact demand. A minor recession, will be met with a measured contracting output response from OPEC and Russia. I think they will defend $80 and $75 like you would not believe.

  7. 7
    kiaora Says:

    Z- What was the deal on getting subscribers? I think I may have one for you.

  8. 8
    zman Says:

    K – free month for a quarterly sub, free quarter for an annual. $25 back for monthly. send me an email @ zmanalpha@gmail.com with their name and I’ll shoot you the cash via Paypal or check when they subscribe. Plus you get my everlasting gratitude.

  9. 9
    Brian08 Says:

    Actually they did…It’s crammed in my brain somewhere around how to do a DCF, etc., etc., etc…My head hurts thinking about it…

  10. 10
    zman Says:

    One of my software providers is having some issues this evening. If you get a message asking for an additional password just hit cancel. Sorry for the inconvenience, I have a call in with them.

  11. 11
    aaatest Says:


  12. 12
    dmharvey8 Says:

    Zman: Thanks for taking the time to respond re Elliott Gue’s analysis. You wrote that Nat gas interest and longs are indicating a top in gas. I read in a blog that commercials are very heavily long in gas, wouldn’t that be bullish?

  13. 13
    Short Term Trading In The New Stock Market Download Says:

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