Wednesday – Oil Prices Begin Retreat Over Demand Growth Concerns

I couldn’t have picked a better day to write about the OIH getting cheaper than yesterday! To be fair I got lucky on the timing. The OIH and the rest of the energy complex simply marked losses in the broader indexes, which took their cue from the strange bed fellows of Greenspan (2H07 recession a possibility) and the Chinese (reigning in growth) – both factors that will reduce hydrocarbon demand.

Oil Was Remarkably Resilient Into The Close Of Nymex Trading… April crude closed up $0.07 at $61.46 in a wild day of trading.

…But When The Dow Took A Header Around 2:30 EST, The USO ETF Started To Trade Off Sharply. No doubt hedge funds heading for the exits. Electronic trading saw NYMEX oil reverse course before the close of stock trading, easily tumbling through $61 as the possible global deceleration and its potential impact on oil demand and prices began to be felt.
Recent demand growth prognostications now in question. From the IEA’s January Oil Market Report dated two weeks ago: Global oil product demand is raised by 111 kb/d in 2006 to 84.5 mb/d and by 273 kb/d in 2007 to 86.0 mb/d following revisions to China. They may have to trim this back some.

Oil Inventory Day: Analysts and Traders Are Looking For More Large Product Draws And A Small Build In Crude. As I mentioned yesterday, the Houston Ship Channel (HSC) was shut down due to dense fog beginning last Thursday and appears to have remained shut through Friday, the last day of the oil inventory reporting period. This is temporary and in my mind provides bears with a sort of “get of jail free” pass. By this I mean seemingly bullish numbers (unless they are vastly out of line with expectations) can be dismissed like non-recurring items on an income statement.

Oil Inventory Expectations (from the Reuters survey) :

• Crude Oil: Up 1.9 million barrels. The change in crude inventories could easily be lower than Street expectations due to the partial week closure of the HSC and potentially could be a small draw on inventories.

• From the beginning of December to the middle of the month crude imports fell by roughly 1.6 mm bopd or 11 mm barrels per week through the Gulf Coast. Then analysts “expected” a draw of only 1.7 mm barrels but got blindsided by a drop of over 6 mm barrels. That’s a long winded way of saying that today’s number could even be a draw on crude supplies as could next week’s report. It all depends on the duration of the closure. However, as always “this too shall pass” and the U.S. remains exceedingly well stocked as seen below:

• Gasoline: Down 1.8 million barrels. With all the refinery outages and an increasing number of local shortages gasoline is moving towards center stage as a key determinant of oil prices. Blending component consumption could easily make this number larger than this which would lend support to crude prices on a normal day. I think the amount of fear in the market will require a much bigger draw than the 1.8 mm barrel expectation to rally/support crude.

• Distillate: Down 2.8 million barrels. I think this is probably a bit light but I’m not sure a “low ball” miss here will prompt much of a rally (at least much of a sustainable one) in heating oil or crude oil this late in the heating season.

Odds & Ends

Natural Gas has been quietly trading lower on the expectation that this week’s inventory report will show a withdrawal somewhere in the neighborhood of half of last week’s pull from storage. Gas sliced through $7.50 overnight and, barring any surprises tomorrow, could be headed towards a test of $7 by the weekend as inventories continue to track towards a seasonal trough of 1.4 Tcf. More on gas in tomorrow’s post.

Spring Is On The Way. The weather “will turn very warm for much of the area that had one of the coldest Februaries on record,” said Joe Bastardi, lead forecaster at AccuWeather in State College, Pennsylvania.~Bloomberg

Opec Watch: Iran says it will “never” stop uranium enrichment, no doubt in a bid to ease tensions and lower oil prices for everyone. Admed’s trying to enrich something all right and not just uranium. Check here for all the latest Iran facts, figures, and er, um critiques.

Analyst Watch: nada.

Putin Watch: Gazprom lowers Rospan’s gas volume transportation allowance in a move critics say is more strong arm tactics designed to force a sale of the TNK-BP venture.

Holdings Watch:

• Small BHI and SLB positions remain ontrack posting nice retrenchments on the day,
• BP puts came back to life after the settlement party of the prior two days was abruptly cut short by the group’s retrenchment,
• sold my XOM position bought at $1.25 over the last 10 days for $1.75 and thought I was lucky to have escaped (that was before the Dow plummetted 200 points while I grabbed a Coke and the $75 March put I had just sold went on to close at $3.30 bid!!! (kick, kick, kick)),
• shied away from any more TSO puts although they reversed hard with everything else. They and VLO may be reasonable shorts going forward as gasoline prices should begin to sort themselves out (that’s code for fall) in the next few weeks as a number of snafu are fixed and refinery utilization slowly climbs out of its current maintenance season induced lull of 85%,
• Picked up a small put position on PTR (March 110s for $1.30 near the close) – a rank wildcat of a trade on the sincere belief that their will be further follow through in the morning on yesterday’s weakness. The better decision was to avoid the temptation to play the early bounce in the market and the group which was brief and would have been very painful,
• HES – the insider selling continues and although the stock fell 4% yesterday it was essentially in line with it’s peers and remains near record highs. I have not yet seen the catalyst (other than substantially lower oil) that can put a real dent in the shares.

Tuesday – OIH Looks Cheap But May Get Cheaper, Also Snafus

Still Fence Sitting But Getting Closer To Squeezing The Trigger. Of the items mentioned yesterday morning:

• TK trickled 1.4% lower as VLCC rates continued to come in and the hang over from the Bear Sterns downgrade made itself more widely felt,
• TSO closed off a whopping $0.30, after a 7% run last week started to cool ever so slightly,
• BP jumped for a second day over giddiness in settling with plaintiffs from their deadly Texas refinery blast, and
• BHI and SLB posted slight gains along with most of the OIH (more on that ETF in a bit) despite my long held put positions.
• Lastly, I continue to watch NXY closely for a breakdown and HES to see if anyone will notice the deluge of shares coming out of management. Otherwise, I continue to watch, listen, and wait for the right time to head back into bigger positions (on either side of the fence).
• One last thing, PTSG re-rallied 15% to $1.42 and I can’t stress enough how quickly I’d recover my cost on this if further gains take place.

Mother Nature Still Supportive of Prices. I’m still concerned about this last blast of cold weather and now we’ve got fog in the Houston Ship Channel. Maybe they should build an elongated dome over it. Billions of dollars for sure but the guys sending the crude put islands in the ocean so how hard can it be to build a several mile long dome in the name of national oil supply security?

• HDDs for last week came in higher than expected at 194 instead of the 166 predicted by the Climate Prediction Center, CPC, a week ago. We can kiss a sub 100 Bcf withdrawal for Thursday goodbye on that news and I’ll have a new, slightly higher estimate in tomorrow’s post.

• Houston Queued Up With No Where To Go. Fog. As of Friday 55 tankers were parked outside the Houston Ship Channel waiting to offload. For a more detailed list of infrastructure issues affecting the price of oil see the section entitled “Snafu watch” later in this post or visit the new Snafu tab if you can’t wait.

A Little Discussion On The OIH. The Amex Oil Service HOLDRs ETF or OIH is comprised of 18 large oil service and drilling companies. The ETF includes a who’s who of service companies Transocean, RIG, the ETF’s largest position making up 10% of holdings down to Hanover Compressor, HC, at 1%. As oil and gas have had stellar rides this decade, so too have oil service company revenues and earnings. My question is whether or not continued out-performance is sustainable.

Oil Service Analysts Point To Charts Like The Following To Show That The Oil Service Stocks Are Cheap… (this chart shows the range between high and low PE multiples for the OIH for a given year)

…And If Current Estimates Hold Up For 2007, These Stocks Are Even Cheaper

But It Took Rising Oil & Natural Gas Prices…

…For The Majors and E&P Companies To Support Service Cost Inflation Like This.

Now Something’s Got To Give Here! Service cost inflation has wildly outpaced production growth yielding large increases in per unit operating costs. Either:

1. commodity prices must continue resume their long-interrupted upward course, or
2. service cost prices must stagnate / fall, or
3. oil and gas companies must live with smaller margins.

Maybe it’s a combination of #2 and #3 that ultimately occurs. Without further increases in oil and gas prices producer margins will be squeezed to the point that they reign in their capital budgets. And if that happens, then everybody (service and producer alike) suffers.

One Last Look At The OIH, From a Component Standpoint. While the forward multiple averages 12x you can see several outliers. Note also that the Street expects earnings growth to slow.

This post will be permanently archived with all my “Big Picture” posts here.

Odds & Ends

Coal Stocks Down Over Cancelled Plants. Should have seen this coming. Nine planned coal-fired generation plants in Texas get cancelled and it’s a bloodbath for the coal miners. BTU took the worst of it but they all had a good run of late on what can only be called meager gains in coal futures prices. I’ll have an update on coal inventories soon (government data willing) but coal production continues to surge. This probably isn’t good news for CSX and the other coal intensive rails either. Trust me, I’m kicking myself over this since I gave up on coal puts two weeks ago.

Energy Snafu Watch: I’ve taken to googling the refiners and energy sites every time oil spikes of late which is not the best of habits but what can you do when things are so jump of late? The latest list of snafus with their expected TTR (time ’til resolution):

• VLO refinery: McKee, Tx 158,000 bopd refinery still “several weeks away from restart.”

• Imperial refinery outage: Expects to run it’s 118,000 bopd capacity Ontario refinery at reduced rates through mid March. Serious shortages and the closure of several filling stations have been reported in the greater Toronto area.

• BP’s Northstar Field In Alaska: 47,000 bopd offline since around Feb 17th and won’t be up for a few weeks as far as I can tell. If it’s not one BP field it’s another. I’d say statements like that are unfair since they have so many fields but then you read stories like this one where management opted to cut costs by substituting water for corrosion inhibiting chemicals and I gotta yell come on!

• TEPPCO refined products pipeline reopened– down a good bit of last week this 240,000 bopd refined products line was coming back up towards full pressure last Friday.

• Houston Ship Channel: The Channel was shut due to Fog last Thursday. If you’ve ever driven into Houston at high speed before dawn you know fog there is no joke. No word yet as to when it will or if it has indeed reopened. This could easily prompt a draw in crude inventories this week and a bigger one next week if the waterway is not quickly reopened.

• Elk Hills is slowly returning to normal capacity of 120,000 bopd after a 20 day outage due to a natural gas explosion in the field.

As I said earlier, I’ve taken this opportunity to add a Snafu tab above so that monitoring of these outages can be a group thing. I’m sure I missed one or two so please feel free to jump in there with those or anything new.
Reader El Diablo came with an excellent Wiki style way of tracking hot topics. The first is Iran and the dialogue (well, currently a monologue) is up and running here. New topics will crop up weekly and get their own thread while older topics will get archived. Thanks El D for a linear method of keeping up with multiple topics! I wonder if we’ll have one on hurricanes when the time comes?

Monday Mullings

No picks today. Stop reading if you want picks. I’m told that the first rule for writers is to never tell the reader to stop reading. Because they often do. But seriously, oil, gasoline, heating oil, and natural gas look extended to me. I’d like to let the week get rolling and exhaust some of last week’s exuberance before I make any picks but if I were to pick anything:

• I’d consider puts on a refiner (very possibly TSO which rallied 7% last week as crack spreads soared on higher gasoline (up 8%) and heating oil(up 5%)) but I’d wait until later in the week,
• I continue to hold smallish put positions in service companies: SLB and BHI but I’m waiting for further action until the OIH establishes a bit more direction — cover over 143, add to puts under 135,
• I hold puts on TK – which saw some pretty handsome estimate reductions last week 10% in 2008 and is near it’s 52 week high. VLCC rates continue to fall as seen here and they were a source of last quarter’s strength the company referred to in their 4Q press release.
• BP continues to recover following the resolution of the Texas refinery fire lawsuits but the company will remain plagued with low growth and operational / managerial problems and I’m considering adding on to my position on this small spike (I’ve got a 2/5ths position now).

Sentiment Watch: I remain bearish on the commodities but acknowledge that the after effects of a rash of refinery fires, pipeline breaks, geopolitcal tension crescendos in Iran and Nigeria will continue to be supportive of oil prices. Combine that with a late February snow storm that swept through the Midwest this past weekend and into the North East and both oil and gas find new floors in what was recent resistance: $60 per barrel and $7.50 per Mcf respectively. I think they break back through these levels, (potentially very quickly) as temperatures become more Spring-like.

Oil & Gas Early Indications: both slightly higher in pre market trading.

Opec Watch: Libya says Iran tensions already factored in, oil prices likely to trade around $60 through year end. Comment: Many analysts are guilty of only being able to see what is currently going on around them (pricewise) and then uttering something within a few dollars of that as their price target range. I expect more from an OPEC oil minister.

Analyst Watch: CAM from SB to B at Matrix.

Sorry for the short post: 1) not much going on in the oil patch, and 2) I’m working on a statistical post and didn’t get on the daily post until late.

NOTE to SA editor – Do not publish today’s post.

Friday Wrapup

Oil Traded Higher After U.N. Report Confirms Iran Still Toying With The Atom. Big surprise. The initial reaction to the oil inventory report was a spike followed by a modest sell off. Then oil reversed course on the Iran news and traded a tad over $61 before closing at $60.95. The crude market remains buoyed by multiple refinery, oil field, and pipeline difficulties and rising geopolitical tensions in Iran and, more importantly, in Nigeria. Here’s a quick review of the yesterday’s oil inventory numbers:

• Crude: up 3.7 million barrels. Much bigger build than Street expectations. Refinery utilization fell to 85.2% versus a Street expectation of a rise to 87%. Gotta wonder why they thought it would rise with the dearth of restart announcements and the recent fires but this lack of consumption on the part of refineries and a small uptick in crude imports are behind the inventory build.

• Gasoline: down 3.1 million barrels. Also much bigger than expected draw down. The decline was attributable due to a combination of blending component consumption as refineries take on inventories in preparation to maker more gas (1.8 mm barrels) and the aforementioned lack of refining capacity coming back on line. Blending component imports also witnessed a sharp drop in imports. On both a total inventory and days of supply basis we remain well stocked for gasoline. However, until news hits that refinery restarts are occurring I’d expect gas to defy the fundamentals.

• Distillate: down 5.0 million barrels. Bigger draw than the Street expected. This was the “bigger” number I’ve been talking about for three weeks. As weather warms up secondary and tertiary sources of heating oil demand will continue to refill their tanks. Furthermore, diesel demand was sure to pick up given the relief from the last several weeks of snow covered gridlock. Over-sized withdrawals relative to expected declining degree days are likely for the next two to three weeks.

Natural Gas Withdrawal Was Essentially In Line With Expectations. The EIA reported 223 Bcf were consumed last week versus my estimate of 210 and Street consensus of 229 Bcf. In comments just before the number (when I finally found a consensus estimate) I wrote: Consensus 229. So maybe the under for gas prices is 220 and over is 230 with little immediate change on a number in between. And gas traded flat to down with the middling report until taking its direction from crude as it rallied on the U.N. report. On the day, gas closed up a whopping $0.08 and remains range bound.

I underestimated the East Consuming Region’s gas demand but otherwise came pretty close…

…But the net impact of 13 additional Bcf taken from storage is minor. I’m bumping my target for next week from 90 to 100 Bcf as I’d rather be conservative than miss the East again. My estimate will change again (probably very slightly) when actual HDDs are released next Monday morning.

I’m Still Banking On Trough Storage Close To 1.5 Tcf. Those smaller end of February withdrawals leave us with gas in storage of just under 1.7 Tcf at the end of February. Average March weather puts at trough storage of around 1.42 Tcf. The wicked cold scenario would leave us with 1.172 Tcf. Anything under 1.4 Tcf at March 31 and I’d give up on gas going sub $5 this Spring (maybe not even sub $6 but it can be surprising how fast a series of tiny, end of season withdrawals, can suck the life out of gas prices).

If I’m Right About February and March Comes In As Average You Get The Following:

Odds & Ends

Opec Watch: Ecuador plans to rejoin Opec during the second quarter.

Analyst Watch: TK cut to neutral at Bear Sterns. Bear cited industry headwinds, valuation, and a lack of near term catalyts as reason for the downgrade and reduced its 2007 and 2008 estimates.

Bad Idea Watch: BP employee (manager of regulatory affairs) deleted subpoenaed files regarding the Texas City refinery fire. She says she doesn’t remember doing it but the judge has ordered them to produce the deleted files by today.

Errata: An ever-so gracious reader on the SeekingAlpha site pointed out at least two of my mistakes in Wednesday’s post. I erroneously stated that TK and GMR were at or approaching all time highs when in fact I meant to say they were hitting or about to hit 52 week highs. I regret the error and any confusion it may have caused.

Thursday – Dueling Inventory Day

Zero Hour = 10:30 EST. Simultaneous oil and gas inventories. Both represent what is probably the last gasp for real winter demand before we enter the lull of the shoulder season (although maybe I’m being a bit hasty as March is still a winter month). To the numbers:

Oil inventory expectations from a plethora of surveys in bold:

• Crude: up 700,000 barrels. Not such an important number unless it comes in way out of line. I’ll be watching imports more closely for clues as to Opec’s compliance discipline.

• Gasoline: up 100,000 to down 900,000 barrels. This number is a crap shoot this time of year. Witness last week’s “unexpected” 2 mm barrel draw attributable to increased consumption of blending components, not an increase in demand or decrease in imports or throughput at refineries. Try predicting that!

The important thing to know about gasoline right now is that it’s becoming increasingly important as we head towards the driving season (about 3 months from now)…and we’ve got lots of it. Click here to see how-full-inventories-are.JPG . Once the discombobulation caused by multiple refinery snafu and pipeline breaks are behind us gasoline should settle down given the shear volume of it on hand.

• Distillates: Down 2.5 to 3.5 mm barrels (I think most are around 2.9). Oil-weighted degree days were still pretty high at 299 and I’d remind readers that the potential still exists for a much larger “end of season” or “top off the tanks” series of draw downs. Prices are pretty robust and will remain so until traders are convinced we will end the season above the midpoint of the 5 year range.

I think we’ll either get a big draw now or it gets drawn out over the next two months. I wouldn’t be at all surprised to see a 3.5 mm barrel pull today.

It’s the potential for a home wrecker-sized withdrawal that keeps me from adding to energy sector put positions right now.

Last of the Big Kahuna Gas Draws For The 2006/2007 Winter.

• My Estimate: 210 Bcf.

• It Was Still Cold Last Week. Last week’s gas-weighted heating degree days of 246 were off recent peak levels but were still 23% above normal and were still the second coldest week recorded this winter in the East consuming gas region.

• Consensus Estimate: Still had not seen one by time of publishing
  

• The over/under is likely to be 200 Bcf. If the report is over 200 Bcf (pretty likely) gas may get a little breathing room. Way over and we break $8 in a rally that will quickly run out of steam. Under 200 Bcf and we start punching daily new lows until we get to $7, then it’s back to closely scrutinizing the forecasts for March.

• Next Week We Should Fall From Triple to Double Digit Withdrawal Territory. My estimate: 90 Bcf (+/-10) . With HDDs falling to 166 the immediate impact will be a much smaller withdrawal.

• February 2007 Was A Big Demand Month, As Februaries Go. The five year average withdrawal for February is 573 Bcf, so assuming I’m close to the mark this week and next and assuming average demand in the final four days of the month, February demand should total roughly 700 Bcf. Here’s what the math on the month looks like:

This would yield February ending storage of 1,718 Bcf (the fourth highest Feb end reading in history).

• Finally No Matter What March Throws At Us, Trough Storage Will Still Be Pretty Comfortable. So what does March look like?
  • The five year average withdrawal for March is 227 Bcf.
  • Going back to 1994 the high and low for March demand are 522 and 142 Bcf respectively.
  • Trough storage generally occurs around the end of March +/- two weeks. Average trough storage is just over 1 Tcf.
  • Based upon my estimate for February end storage of 1,718 Bcf: So an average March yields trough storage of 1,491 Bcf. This is pretty much in line with my 1.4 to 1.5 Tcf in storage and should serve to put a damper on gas prices.
  • The wickedly cold scenario yields storage of 1.2 Tcf which still doesn’t support current $7+ gas prices! To be honest if March forecasts start looking like that kind of an Arctic beast I’ll go long CHK, SWN, KWK and a few others while I wait for April.

Odds & Ends

Analyst Watch: nada.

New Holdings Watch:

• TK – penny miss to par depending on who you ask. Estimates ranged from $0.98 to $1.24 with 13 analysts posting numbers. Costs look pretty high but guidance given on the conference call this morning will guide written opinions later today and tomorrow.

• GMR – In line with estimates. Announced $15 special dividend that was well liked by Street in after hours trading sending the stock up 10%. This is why I don’t do earnings plays and why I always scale into position (and why I shy away from front month contracts).

Great Bloomberg article on the rising cost of hydrocarbons.

Waiting Wednesday

Oil Inventories Postponed Until Thursday. Gas Inventory Report To Arrive At Usual Time. April crude is indicated off another $0.50 after a $1 tumble yesterday. Natural gas continues to rally into what is likely to be the last of the 200 Bcf withdrawals of the season (more on that tomorrow).

• I’m still looking for oil to test $55 before it’s able to to muster a small bounce. Then downward to the lower $50s.

• Gas should soften up next week, especially if next week’s pull from storage is less than half of this week’s (which I’m betting it will be).

Earnings Watch:

• TK and GMR after the close. Talk about priced for perfection its at all time highs but earnings numbers are expected to fall from $1.70 to $1.07 for the former and from $1.71 to $0.72 for the latter. Lower rates, lower volumes. Guidance here is crucial. I’ll be taking some $50 March puts for a buck on TK and some April 35 on GMR which is up 10% in the last two days. Both will be 20% opening positions. Also will take a few TOPT $5 calls or puts tomorrow morning depending on the results tonight.

• BRNC – announces Thursday and has already been downgraded by everyone on the Street on the expectation of reduced onshore drilling activity. While I expect activity to fall as well it hasn’t yet and is in fact increasing. Ratings may have come down here but estimates have not and BRNC trades at a mere 6x forward earnings (cheapest driller I can find). I’ll be taking the April $15 calls (20% opener) before the report. Normally I’d say that the cheap get cheaper in a falling commodity price environment but with activity remaining high I’m suspending that rule here.

NXY Watch: The chart is on the brink. It’s unlikely they will be able to post better than expected production guidance in coming months as their growthy, long lead time projects have been well telegraphed. They have set the bar very high for 2007 (50% production growth) but given their high forward multiple relative to their peers they are likely to trend lower in the current falling commodity price environment.

CFTC Report Shows Marked Increase In Natural Gas Short Position Last Week. After a brief bounce towards equilibrium at the start of the month, the shorts reasserted their bearish sentiment last week. Concurrently, the longs continued their 5 month long exodus from gas reaching the lowest level as a percent of total contracts in 8 months. (click on the graphs below to open in a new window)

Longer term a large net short position could provide the impetus for a rally. Historically, the pendulum swings much further into short land before this occurs. These reversals usually occur when longs represent as little as 15-20% of outstanding, non commercial contracts. With the longs at 45% of total we’re not there yet.

…But For Now The Slide In Net Contracts May Bode Poorly For Gas Prices. In the last two instances where the net position plummeted from high to low levels (2001, 2003) gas prices fell substantially once the net position tipped into short territory. Looking at the chart below you can see that there is not a simple relationship between gas prices and net contracts. However at the extremes the CFTC data would seem to be predictive of significant moves in gas. If the net long position spirals toward the low end of the range again (15-20%) it would suggest that gas prices will come in (to the $5.50-6.50 range).

Odds & Ends

SPR Refill To Commence This Spring. Secretary Bodman said the U.S. will start purchasing 50,000 bopd to begin refilling the 11 million barrels sold from the SPR to refiners in the wake of Hurricane Katrina. As the secretary said, this shouldn’t have any impact on crude prices.

In a never ending attempt to support oil every time prices start to waver BP said it shut in its 47,000 bopd Northstar oilfield in Alaska after discovering a pinhole sized leak in a gas line. No word yet on a repair time line but BP will likely take their time as they’ve stated they have some other facilities upgrades to do during this outage.Analyst Watch: VLO PT upped from$79 to $82 at FBR.

Dykstra Picks HAL. When investing becomes entertainment you’re near the end of a bull market. First Mad Money, then Fast Money, now Sports Money?

Tuesday Morning…Warmer.

Oil: It’s All About The Rising Temps. Crude fell $0.89 to $58.50 in electronic trading yesterday. This morning oil is indicated down another $0.37 as the first real forecast break in the weather in five weeks materializes.

First Taste Of Spring – It will be brief but very warm.

Natural Gas: The Last of the 200+ Bcf Withdrawals (of the season). I’ll go out on a limb here and say we get another 200 Bcf withdrawal this week and then that the season is essentially over. We’ll probably enter the injection season with a little over 1.4 Tcf in the can which is near 400 Bcf over normal.

• The Over/Under Is 200 Bcf This Week. My best educated guess is that prices will decline towards $7 this week and then either plung below it on a <200 Bcf report or surge back to that top of $7.50 I mentioned last Friday.

• Next week I expect a high double digits withdrawal (around 90) as the warmth of Spring slowly spreads to the northeast. gas-weighted heating degree days (GWHDDs) came in at 246 down from 267 last week and 258 the week before that.

Here’s what that will look like on a YoY storage deficit basis.

This Week’s Degree Day Tally Should Fall Off A Cliff So Next Week’s Storage Report Should Be Cut In Half (At Worst)

Odds & Ends

Rig Counts Remain High. Baker Hughes rig count increased 13 last week (all oil). Gas rigs remain at all time high. Note also the rapid growth in horizontal drilling. This is primarily gas and of that primarily shale. The slight downturn at the end of the horizontal chart may reflect maturation of the core Barnett properties and a reluctance to maintain capital programs at recent levels given last years slide in gas prices.

Opec Watch:

• Opec Says Market Is Fine For Now. According to the new Opec Secretary General, production cuts in March are unlikely and he added: “Supply and demand are running neck-to-neck,” at around 86 million barrels a day. “Adherence to the cuts is excellent at 66%.” Comment: Normally I think of 66% as a D but it gives you a good idea of how to discount any future cut claims these guys make.

• CNN reported Iranian vessels have strayed into Iraqi waters at least twice over the last week near an Iraqi oil export terminal. They left after Iraqi patrol boats asked them to. Comment: “This business will get out of control. It will get out of control and we’ll be lucky to live through it” ~ Tom Clancy.

• Russia Cuts Oil Price Forecast. From Bloomberg, Russia, the world’s largest oil producer after Saudi Arabia, cut its forecast for crude prices this year and next, Deputy Finance Minister Tatiana Golikova told parliament today, according to local news services. The ministry cut its forecast for 2007 to $55 a barrel from $61 a barrel and the 2008 estimate to $53 a barrel from $56. Comment: They won’t be #2 for long and they know it.

• Nigeria. Another day another three hostages taken.

Analyst Watch: RBC and Jefferies initiate with buys on RAME after its secondary (priced in the hole) earlier this month (Do a deal, win a prize!), SUN upped to Buy at DB, XCO (the guys buying a lot of APC‘s castoffs) cut to hold at AG Edwards. UPL upped to buy at Goldman.

And lastly…from a Bloomberg survey, 21 of 42 analysts, traders and brokers, said [oil] prices will decline this week, 10 expected an increase and 11 forecast little change. The week before, 35 percent of respondents expected futures to fall. Comment: I continue to see $55 as the next test followed by a small bounce as we head towards the lower $50s. We remain extremely well stocked for crude and products.

Stocks Of Interest This Week:

Longs:

AXC – this really reminds of TLM in its infancy with bigger growth and large, near term catalysts off the coast of Nigeria and, in of all places, Iraq,

PTSG – high potential, high risk Barnett Shale play,

CRZO – lots of shale exposure (not just the Barnett) in a little package could yield big growth,

CRR – frac business is booming while the frac mapping and reservoir diagnostics business is hitting on all cylinders as well.

Shorts:

BHI – waiting for the other shoes (Goldman & Lehman) to drop,

ACI / BTU – coal is backing off with gas and recent production runs show continued increases in production,

Refiners (HOC, TSO, and VLO) after we get some clarity on the latest VLO fire (that’s 3 in 2 weeks!),

Others: BP, HES, MUR, PBR, PTR, SU (buyout rumor is overplayed here and recent high gas and low oil make SU a dull boy), COP (gassiest major of the all will slide if gas goes sub $7).

Finally Friday

Opening Indications: Oil down $0.15, Natural gas up $0.03.

Natural Gas Sees Monster 259 Bcf Pull. This was the second largest withdrawal in history prompted by a record withdrawal from the Eastern consuming region. Given the current weather outlook I’d say this was peak demand for the winter of 2006/07. After a few hours of indecision traders decided that a number over 250 Bcf was in fact, bullish and boosted prices by a nickel in very boring trading.

Oil Dove, Then Rallied On Another Refinery Fire. I Still See It Lower In The Next Two Weeks. The rally in natural gas also corresponded to a $1 recovery rally in crude which closed flat on the day. Crude rallied on news of yet another refinery fire, this time in Ontario. Unless the 118,000 bpd facility is seriously damaged I’d bet this support will be extremely fleeting. Here’s my thought on oil for the next two weeks. $55. Then a small bounce followed by comments like “people are flying kites in the midwest and wearing shorts in Texas.” Then $52ish. Then Opec starts chirping and the rally mechanism tries to kick in again. One caveat: no other infrastructure blows up and Ahmedinejad doesn’t smoke a peace pipe.

Gas Inventories Are Still 15% Above The Five Year Average

• Storage as of February 9, 2007: 2,088 Bcf (updated February 15, 2007).

• Max storage for this week in history: 2,266 Bcf (2006). At present gas is at it’s 3rd highest level in history for this date.

• Thanks to a small withdrawal in the comparable week a year ago and the large withdrawal this week we have fallen 8% (178 Bcf) into year over year deficit.

• We remain 15% (268 Bcf) above the 5 year average.

• If you take the coldest 7 week period (mid February to the end of March) over the last 14 years you get demand of 675 Bcf which would still leave 1,413 Bcf in storage. That’s well above the 5 yr average trough level storage (end of March) of 1,025 Bcf (excluding 2006’s warm and Katrina impacted levels).

The Eastern Consuming Region saw an all time record draw of 179 Bcf. This caused me to fall a bit short of this week’s 259 Bcf report. Stories of freeze ups in the western region apparently didn’t have much of an impact as only 12 Bcf were pulled from storage.

So What’s Next For Gas? In the near term that of course depends on the weather. The current two week forecast calls for a return to warmer than normal temps which probably puts a limit on gas of $7.50. However, a late season cold snap could make my $5 gas call during March a remote possibility. The fact they we’ve fallen into deficit is no surprise and though its duration may be short lived it will serve as a floor under gas, say $6.50, until we get some double and not triple digit withdrawals (probably another 2 weeks).

From Yesterday’s EIA Gas Comment: The continuing large storage stocks pose the possibility of incremental natural gas volumes entering the market before the end of the heating season as holders of storage capacity rights strive to meet contractual obligations to ratchet down storage volumes by specified dates. Comment: this is the storage cycling Ggas has been commenting on. If you combine this necessity to cut storage levels with the fact that Henry Hub gas prices are close to $9 right now and the March futures contract is at $7.35 you can see the economic incentive to pull gas from storage.

Longer Term I Still Expect Natural Gas Prices To Decline. There are several factors which bode for further/renewed declines in gas prices. Chief among them are:

• increased production from Texas (laregely Barnet Shale), which had been flat for years prior to 2006 and
• continued growth in Wyoming gas production (CBM, anticlines, etc).
• High onshore rig activity has also arrested declining production in Oklahoma and is boosting product in other states not normally known for gas production via a variety of new shale, tight sand, and/or CBM plays from Arkansas to Michigan.

In aggregate these volumes do not replace the massive drop in Gulf of Mexico volumes that has occurred over the last decade. However Gulf volumes are not falling as fast as they once did due to greater gas production from deepwater plays. This means we may have reached a near term trough for domestic gas production. Combine that with an expected increase in LNG volumes over the next two years and some of the tightness in the gas market starts to relax. I’ll have more in a report on this soon.

Odds & Ends

Holdings Watch:

BHI obviously helped my performance yesterday with it’s nearly 10% drop. Will continue to hold as investors dump a management team that used many forms of the word uncertain in describing the current business environment and was reluctant to give guidance for 2007. I’ve only seen one downgrade so if we could just get a few more bulls to pull in their horns and let the stock fall below $65 that would be great…thanks.

• The fellas at Motley Fool referred to managements handling of the conference call as how to “butcher a quarter” but I’m too nice a guy for that kind of talk. I’ll just hold my March puts a little longer as it gets pummeled, gets whacked, is reassessed by investors and analysts as to its proper forward multiple.
• Of course this was also a Goldman Sachs favorite and Abbey Joseph Cohen included it in the Barrons Round Table on January 21 as one of her top picks saying “it’s selling at a discount to peers due to problems, soon to be rectified.” Soon is such a relative term. They actually upgraded the stock on Dec 18th at $78.80 some I’m sure they’ll like it at $65.

SLB – continue to hold feeling that it may start to suffer from BHI‘s honesty regarding the domestic environment.

Also taking a hard look at Calls on AGU and POT right now. Fertilizer companies directly benefit from falling gas prices. AGU has had a good run but is still by far the cheaper of the two. POT has access to cheaper Canadian gas and is forecast to grow faster even though it’s over 3x the size of Agrium. This makes a nice hedge for my gas puts.

Opec Watch: From the Gulf Times: Opec also said it may cut its forecast for growth in world demand this year from 1.2mn bpd, or 1.5%, should there be a return of the exceptionally mild temperatures in the US that curbed oil use earlier this year. They also indicated OPEC may need to pump more as they now forecast slightly lower supply from non-Opec sources in 2007.

Analyst Watch: CSFB downgraded BHI to Neutral last night and Calyon reduced its rating from Buy to Add. The overwhelming majority of analysts here have buy ratings and prices targets $20 to $30 higher than here.
Earnings Watch & Review:

COG reported a slight miss but good F&D costs and reserve replacement. Probably no action there.

XEC also had a one penny miss. Reserve replacement was not nearly as exciting here and production guidance is pretty tame. They did report shut in production due to ice storms in Kansas, Texas, and Oklahoma. I’m looking at puts on any gas related bounce. Have to do more work here before getting serious but the March 35s for $0.45 are pretty tempting.

Thursday – Oil Review & Gas Preview

Indications: Oil up $0.04 Natural Gas up $0.02 (and meaningless until after inventories)

Oil Review: All Categories Show Withdrawals: Gasoline Bigger Than Expected, Heating Oil Less. The result was an initial WTF? from traders as oil began a five minute ill fated rally which quickly failed to levels below the prior day’s lows. Crude settled down $1.06 to $58.00. Street consensus estimates in bold with comments in italics

• Crude – Estimate: UP 0.6 to 1.6 million barrels. Down 600,000 barrels. We remain well above the five year average for this time of year. The downtick inventories this week was attributable to a modest rise in refinery utilization which was partial offset by higher imports and domestic production. I see you cheating again Opec.

• Gasoline – Consensus Estimate: UP 2 million barrels. Actual: down 2 million.
  • 1) Three-quarters of the decline was attributable to consumption of blending components. In past years this activity has occurred at the beginning of the switch to increased gasoline production in preparation for the driving season some 3 months away. Said switch is actually a misnomer since we’re talking about a few percentage points change in the ratio of gas vs distillate production.
    
  • 2)This was the 2nd week of higher prices on the wholesale level. Many gas stations are only keeping the bare minimum of gasoline on hand, and in many cases they are opting for weekly refills to keep their inventories at only 10% of capacity. Anyway its forces them to continual mark their inventories to market and avoids the losses many of them suffer with rapid swings in wholesale prices. When they see prices start to recover many of them bump up their minimum inventory a bit and that could explain some of the unseasonal timed draw on stocks. I’d also note that many consumers are doing the same thing with their cars getting five bucks at a time. If they see prices start to creep up maybe they get $10 to buy a little time.
  • Cash gasoline prices rose another penny on the news after an $0.08 increase on Tuesday over the Valero fire. This rally won’t last.

Closing comment on gasoline. So why are the refining stocks doing so well right now? The short answer is that although the recent (last summer) cracks are probably not going to be that lucrative again for quite some time the companies are cash flowing nicely and product prices have taken a strong bounce over the last four weeks. That HOC valuation looks way out of line but I’m not going there this week and as for the rest I’ll wait for a clear signal from crude.

• Distillates – DOWN 4 to 5 million barrels. I think this number could be a lot bigger than this. Actual: Down 3 million. OK, so I was right last week and am happily wrong this week. Heating oil fell a nickel on the news.
  

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Note: If we get average withdrawals from distillate inventories through winter’s end we still don’t break the mid point of the preceding chart.

Valentine’s Day Massacre For The Shorts. There’s nothing worse than having all of the commodities from oil, to heating oil, to natural gas and even coal fall while the underlying issues for your entire portfolio of put options go against you. Ok, there are worse things but I really hate it when that happens.

The Street continues to love the stocks; fundamentals be damned. Yes earnings estimates are coming down due to lower commodity prices and higher operating costs and yes valuations on a total enterprise value per Mcfe continue to climb (more on that soon), and yes production growth continues to be a problem and yes the best crack spreads for a good while are the ones in the rear view mirror. What was my point? Oh, right. buy, Buy, BUY.

Gas Storage: Expecting The Biggest Withdrawal Of The Season. This should come as a surprise to no one since last week’s mega HDD number of 267 deserves a mega withdrawal to match. In the East Consuming Region we had extreme and ubiquitous cold and while the western region enjoyed a slight break from the blizzards of the last few weeks stories of well freeze ups should bolster withdrawals there as well.

• My Estimate: 245 Bcf. Biggest of the season and driven by the eastern region. I went back through the decade looking for a colder period in the east and stopped in January of 2000 when the region saw it’s largest ever storage withdrawal of 171 Bcf. Degree days then were a whopping 1,243 vs this week’s even more massive 1,325. I’d think twice before going against the gassy names tomorrow at least until inventories are reported as there could be substantial upside to my estimate.

• Street Consensus: 252 Bcf.

So the over/under is 250 Bcf. Beat the number and gas makes that long awaited run on $8. Even if it makes it, the current forecast makes today’s number the season’s peak for withdrawals. Then it’s time for the hangover. If we miss the number to the downside, then we shoot back through $7 and the hangover is much more painful. Either way, nothing about the pre report trading matters so don’t be fooled by it.

One last thing, we’re due some better comps in coming weeks as there was some late season demand last year. However, this week is up against a tiny withdrawal in the year ago period. This means that for a time, however brief, we are boldly surging into YoY deficit territory which the media (you know who you are and how conflicted you must be) will only be too happy to highlight every 15 minutes.

Odds & Ends

No picks this morning and only maybe after inventories. Stocks are on steroids with the broader market. Take heart though. This weekend I’ll endeavor to find a few good longs which is a sure sign of a top.

Earnings today: BHI (sell the initial dooms day response), COG, XEC, ECA, NXY

Kathmandu Gets 1st Snow In 63 Years. Now that Exxon has embraced global warming can we at least change the name to something more descriptive? We’ve got snow piled up to record levels in New York and now it’s sleeting in Nepal? Global warming seems off the mark. Even Rapid Climate Change is hard to grasp since no one has that kind of attention span. I propose Geographic Climatic Transference Syndrome. It simply means you’ll get weather unlike any you’ve ever experienced, it may be bad but it may mean you can ditch the snow tires. It’s also a catch all so the media doesn’t have to stop running stories about it’s when the headline doesn’t match the their desired outcome.

Analyst Watch: ACI PT cut from $45 to $41 at RBC.

Wednesday – Inventories Set To Disappoint, But Any Rally Will Be Brief

Oil Rallied As The International Energy Agency Boosted It’s Oil Demand Forecast, Then Nudged Higher By VLO Refinery Fire. March crude rallied $1.25 to $59.06 yesterday as the one two punch of forecast higher global oil demand and yet another oil industry fire boosted prices. Spot gasoline shot up $0.08 to $1.62, more than reversing the prior day’s slide and continuing the rally that began with crude’s advance in mid January. The refiners, including VLO which had the fire, soared. Some takeaways from yesterday’s action:

• The Impact of IEA’s Demand Forecast Will Be Fleeting…The International Energy Agency revised its estimate of growth upwards by 273,000 bopd in 2008 to 1.55 mm bopd for total demand of 86 million bopd. The increase was primarily the result of a revision to Chinese demand.

• …But Saudi Arabia’s “Healthy Oil Market” Will Have A More Lasting (and bearish) Impact. Saudi signalled they are done curtailing production (they even mentioned increased shipments to Asian refiners in March) which sort of defangs the OPEC hydra.

• VLO reported a small fire at a refinery in Delaware (the second in a week)… The company said it contained and extinguished the small fire but no timetable for resumption of operations has been announced. Also remember that VLO expects to restart its larger Texas City refinery next week which was damaged by fire January 28th.

• …But the overreaction looks like last week’s Elk Hill’s advance. The majority of today’s reaction was mostly due to the latest refinery snafu; prices spiked on the news and never looked back. It reminds me of last week’s Elk Hills rally which sent crude up $2 for a day until everyone realized it wasn’t that big a deal.

Holdings Watch: Energy stocks rose more on a $1.25 increase in crude than they fell on it’s $2 decline the day before. Do that long enough and you get this. A state of denial remains in effect until further notice. Oh, we’ve got a few of the more daring research shops looking into the impact of lower commodity prices and ever escalating service costs on E&P cash flows but their clarion call is not yet widely heard. At the bulge bracket firms, energy remains near the top of the recommend list where a recovery in commodity prices, not production growth or cost curtailment, is key to their continued predisposition towards Buy ratings.Here are the estimates from Bloomberg’s weekly survey:

• Crude – UP 0.6 to 1.6 million barrels (to ~10% above the 5 year average). While the weekly number here remains less important that heating oil (and increasingly this time of year, gasoline) unless it significantly misses the mark in either direction the magnitude of supplies must begin to put pressure on crude, especially as we enter the shoulder season.

• Gasoline – UP 2 million barrels. Gasoline inventories are already well above the five year range and the rebound in wholesale prices should quickly abate if we, as expected, get the ninth consecutive build in inventories.

• Distillates – DOWN 4 to 5 million barrels. I think this number could be a lot bigger than this, but even with a 8 mm barrel draw (not inconceivable) distillate storage would remain slightly above the 5 year aveage.
  • Oil weighted HDDs soared to 332 last week versus 282 in the week before when the withdrawal of 3.7 mm barrels also exceeded estimates. Unless there is a marked increase in refinery utilization and it’s directed towards distillate production I don’t see a number as small as the predicted 4 mm barrel pull.
  • Moreover, those secondary and tertiary stockpiles have to be refilled after this many consecutive weeks of cold weather.

We Could See A MUCH BIGGER WITHDRAWAL From Heating Oil Inventories (so wait to see what happens before taking on new positions). 2003 was very similar to this year in that the winter like weather got off to a late start. In the second half of January oil weighted degree days crossed the 300 mark and draws on distillates quickly grew from nothing to 3 mm barrels , then 6 and finally 10 million barrels. None of those degree day readings surpassed this past week’s 332. So again I’m being careful and waiting for the post inventory exhaustion to set in. If the number is over 5 million barrels it may provide the impetus for a jump to $65 but I think it will be short-lived. Next week’s early read on degree days shows a marked warming trend.

Odds & Ends:

From The EIA’s Natural Gas Page: Beginning with the March 2007 issue, (data reported for January 2007) of the Natural Gas Monthly, EIA will present more timely natural gas production data (collected on the Form EIA-914, “Monthly Natural Gas Production Report”), that will result in changes to data elements and table formats. The impact of these changes is discussed at: http://www.eia.doe.gov/pub/oil_gas/natural_gas/data_publications/natural_gas_monthly/historical/2007/2007_01/pdf/impact914ngm.pdf

Comment: Better late than never no longer applies. Halleluja. Data reported in March will be for January. That’s one month better than current reporting. One caveat: timeliness = less accurate/specific data. They’re cutting out some state level detail and the oil well gas (casinghead) vs gas well gas split. You’ll have to wait for the EIA’s Gas Annual for that.

Analyst Watch: Very quiet. DO PT upped from $90 to $118 at FBR.