Friday, May 9, 2008

Our April 14 Range Upgrade for Crude Was Well Timed

... and that begs the question of where to next? Crude cannot sustain this advance indefinitely. With the month only 9 days old -- yes, some like it hot, some like it cold, some like it in the barrel 9 days old -- WTI light sweet is up a stupendous 11% month to date! Thus, the rise has become quite parabolic and the danger of a short and sharp correction should be a part of every trader's thinking. (See our crude trading range upgrade from mid-April a few posts below.)

Lesson learned from this recent leg up? 87 mln is the number to remember. 87 million is about DAILY world consumption of barrels of black gold. 87 MILLION 42-gallon barrels of crude on the wall.. you take one down, pass it around...

Pundits have been puzzled by how the dollar can bounce from its lows, yet crude continues to go higher. They forget that crude is not just about the dollar, or U.S. supply/demand. China demand has doubled in just the last decade, for example. Non OECD demand will continue to dog the crude bears and lend major support to energy prices. The OPECers are only a few million barrels from their peak light sweet crude production capacity and non OPECers have been slow to grow their output.

The numbers say it all
I'm convinced pundits don't study this kind of stuff, but a close examination of the stats gives enlightenment on why this has been a bullish trade. Talk about fund manipulation is blather - it's all in what's going on in the world.

While we have been energy bulls and and agree with Goldman Sachs that a spike to $200 is likely, we're still open minded enough to realize that parabolic markets are bound to correct and even sharply so. Now that articles are starting to pop up in the financial press practically encouraging people to go out to their backyards and drill for a gusher, there are some signs of mania. Ok, I exaggerate obviously about drilling in the backyard, but talk about the virtues of energy ETFs, for example, are sure signs that the trade is getting very crowded. Be careful since in a secular energy bull market, the corrections have tended to be short and sharp (recall the last time we saw the $50/bbl v-shaped bottom). Crude is a market which is driven by fear of supply disruptions in the most unstable of the OPEC nations, worries about overall resource depletion and geopolitical factors like war with Iran, etc. These are factors that won't be arrested just because the price of crude corrects. You can bet that crude shall resume its upward trek once whatever correction runs its course.

I would add that gasoline crack spreads being more than 50% below home heating cracks is another factor that is keeping the market guessing over whether gasoline supplies here in the U.S. market will make it to the market's comfort zone going into the summer driving season. There's no scarcity of the crude to make gasoline, or even a scarcity of mo-gas itself, but an incentive exists for refiners to make more HO and other distillates and less RBOB which adds further uncertainty.

In very quiet fashion, natural gas has very meaningfully rallied to pre Katrina/Rita highs. Over $11 per decatherm in May?!? Thank goodness this isn't winter, or we'd be stung by a combo of shock at both the gasoline pump and with the monthly heating bill. I pity the Nat Gas short (fool) if there is any sign in the months ahead of a storm that would threaten Gulf of Mexico energy assets. An unusually hot summer would also stress the supply/demand balance. And i pity all who are being setup for a winter time shock with the heating bill. The heating bill would be the final nail in the coffin for many consumers. Any direct hits to gulf energy -- then we're talking $20+ natty. This adds up to a bullish looking trade for nat gas, though a sharp pullback in crude would temporarily pull the overall energy complex lower (which would mean an even better entry point for nat gas).

So our range for nat gas going into hurricane season is between $8.50 and $25/mmbtu. Sorry for the wide range, but a third straight uneventful hurricane season would send nat gas a bit lower, while another Ivan, Rita, or Katrina would mean game over. We just don't have a magic weather machine that will tell us what will happen between June 1 and September but recognize what's at stake in terms of how the weather behaves this year since nat gas prices are already high. Remember, preliminary winter forecasts that will begin to emerge in the Labor Day time frame will also impact the price of NG before the official end of summer. So, regardless of the unknown of summer weather conditions, we're also bullish on natural gas. For that matter we're bullish on natural gas, crude, gasoline, propane, electicity, wood stove pellets and fire wood over the longer term.

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