When Crude Drops, AMR Will Fly

I have been watching in amazement while the price of crude strangles the world's economy at $139/bbl. There have been riots and strikes in Europe as gasoline and diesel approach $10/gal (U.S.). In the third world and developing countries, many people have to decide between driving or eating.

Crude is up 57% since February and doubled in a year. In early June it rose 13% in a single day. I haven't seen something move like this since the solar stocks in November, 2007 or the Nasdaq in March, 2000. But like those former parabolic critters in the rear view mirror, the current commodity speculation in oil being is pawned off as something unique - a "supply/demand" crunch or peak oil (as in the difference from Monday to Tuesday). Yet it looks to me like just one more chapter in the age old myth of "It's different this time".

The price of crude is oscillating up or down 5% per day. FIVE PERCENT between the time you wake up and the time you go to bed each day. That's what markets do when they top out. Valuations go crazy.

And parabolas revert to their mean. And If this speculation is gonna revert, I think it’s soon. China - the world's second biggest consumer of crude - finally took the gloves off and told their populace the government will no longer subsidize a discount per gallon of gas, starting tonight. There will be a 17% rise in gas prices, 18% rise in diesel, and 25% rise in jet fuel. Not only that, the Saudi OPEC ministers are having an emergency meeting this weekend about the relentless rise of crude prices.

Which leads me to the lowly American Airlines (AMR), the airline that's in the newspapers all the time because of their surcharges on everything that moves (to keep from drowning in red ink). In 18 months the stock has dropped from 40 bucks to 5. The cost of crude is the main culprit. Other than that it's a very well run airline (okay, maybe no airline is a good business, but I like em). 

During the bone crushing drop from 40 to 5, however, there have been occasional moments of luminous hope - whenever the price of crude abated. There were five (5) separate counter-rallies lasting a week or two for 25%, 34%, 24%, 43%, and 26%.

Four (4) of these mini-spikes were in the last 5 months, and the 6th might have begun today. Can the oil speculators break every central government in the world? An interesting question. For that we'll have to stay tuned. Thus far no one's been able to stop them. But on the other hand, could the mother-of-all-short-squeezes have begun today? 

If crude goes to the mat, AMR is gonna fly - literally. And the volume in the stock at these humble levels convinces me that some savvy investors are thinking the same thing (see chart below, click to enlarge).

Disclosure: John Gilluly has a long position in AMR.

Comments

[sliman]

China raising prices will be BULLISH for oil. Production of gas will increase and demand will not drop because their economy is strong. There would have been gas lines with out increase in production.

[echang]

absolutely agree with you Gilluly. Plus the very fact that airlines are beginning to cut capacity and flights will reduce gas consumption. The aggregate global airline industry uses approximately 5 million barrels a day. And to Sliman, can China grow forever. They are already beginning measures to slow down their economy, raising interest rates and increasing bank reserve ratios. Their stock market has already crashed, is their economy going to follow with a slowdown? Oil very well might keep going up from this point, but its bound to pullback because the supply/demand equation that existed is starting to disappear.

[BS Detector]

"China raising prices will be BULLISH for oil. Production of gas will increase and demand will not drop..."

Let's see. You say supply will increase, and demand will stay constant, and oil will increase in price? Care to apply ANY economic theory to support this notion?

[NormanQ]

AMR has a very reasonable chance of BK. HELLLLOOOO.... Big time speculative play. Buying AMR is as risky as buying oil right now. Have fun trying to catch the falling knife.

[BS Detector]

Oh yeah, and Sliman? You might want to read up on it before you say something like "There would have been gas lines with out increase in production."

www.nytimes.com/2007/1...

The picture's worth a thousand words.

[galewhitaker]

John - How foolish is it to assume that their is an unlimited supply of cheap, easy to get crude oil. Remember in college they taught us about "declining resources". The amount of oil is declining just like gold and the prices are going to go up for the rest of time, just like gold.

[Manifestor]

I can see some correlation here. Here goes my logic:
Oil price movements are on every regulators' radar screen. Assuming a fair amount of speculation in oil, and given such huge price volatility, speculators must be looking for a way to diversify. As a result, when they move part of their money out, oil price will fall and that will boost airlines among others.

[Eagle-Chief]

....When hell freezes over, snowmen will flourish....

[CaptBob]

Right Chief: Want a play on flying when Oil backs down??
Forget AMR, go for Pig saddles, AMR will be mothballed and the Porkers will have all the best routes---And a Kosher dinner!!

[regeya]

"And to Sliman, can China grow forever. They are already beginning measures to slow down their economy, raising interest rates and increasing bank reserve ratios."

Not to mention that both their and India's GDP may be overstated by as much as 40% apiece...

[bds231]

Sliman, your post doesn't seem to make any sense. Care to elaborate on your projection?

This post is an interesting idea... but who's to say oil won't stay up long enough for AMR to fold? And given the huge daily swings in the airline stocks lately, the risk of being long AMR, even if you're right in a few months, would be huge. Wouldn't it be easier to buy puts on USO to capitalize on this thesis?

[dtv999]

Hah! I bet all those rallies are due to short covering. Been there myself.
AMR is in a more difficult position than the others because they didn't go Ch11 after 9/11 and are still carrying the old debt. On top of that, they wont' be able to get any more concessions from the unions this time. So unless the author is talking about a short term trade, I wouldn't bet my
money on AMR.

The entire airline industry is a big mess perhaps with the exception of LUV. Interestingly, if oil drops too much LUV will be the one in trouble because of too much hedging and higher labor costs .

[francis schutte]

When Oil comes down, AMR will surely fly. However with Peak Oil it will be extremely hard to get a 'slot time' for departure. This ain't a bubble. Stocks keep on coming down as there is a 700,000 barrel shortage between demand and supply. Such a shortage cannot be solved overnight. Airplanes don't fly on solar energy! (see peak oil on the web page)

[pachanguero]

This is about the most stupid thing I have every read on this site.

[liquideagle]

China raising gas prices will be BULLISH for sweet crude and BEARISH for the heavier stuff. Currently Chinese refiners have had little choice but to buy the cheaper harder-to-refine stuff as the they could not turn around and sell the more expensive sweet crude at any profit - because of the subsidies.

[echang]

well sliman could be partially right...

chinese oil refiners have always tried to purchase as little oil as they could because they sell gas at a loss. if the government increases prices, it might make sense for them to buy more crude oil because quite honestly, chinese consumers weren't getting enough gas at the old prices. oil shortages and lines at gas stations were quite common. Don't know if this still holds true at current prices, nytimes article seems to think it still does. Regardless, many economies seem to be slowing down. Many traditional gas users seem to be slowing down. The bearish story is still unfolding. Only time will tell if its correct

[princeh]

You could not be more right....can we say that in English?
I think all of the Airlines deserve a good look in this regard.

While we're at it why not look at Ford Motor Company for the same reason. Let me get my shovel and pen out....there's some work to done here and some bargains to be had...............if there's anything let after filling up this tank....hmmmmmm.

[Equitywavetrader]

Well, 6 weeks have gone by, oil is dropping (like a rock) and AMR is up 125%. I think the premise still holds. The plummeting stock prices in the oil index appear to anticipate crude at $70 to $90 which I think puts AMR in the twenties - another double from here.