Oil Set To Fall While Gas Continues To Hang On With The Cold

Includes: CHK, KWK, OIH, SWN, USO, XLE
by: Steve Zachritz

Oil needs to hit $60 before I take further action. The March contract had another strong performance making considerable progress in its march towards $60 last week. The contract closed up $3.50 on the week to $59.02 despite continued large builds in crude and gasoline stocks reported Wednesday. True, there was a draw in heating oil stocks that was either in line or slightly bigger than expected depending on which survey you pay attention to (Dow Jones or Bloomberg) but this is the first pull from storage in 7 weeks in the dead of winter and inventories are still well above average so it’s hard to see the bull case based simply on that (though CNBC tried).

  • The last minute rally on Friday was inspired by a rumor that there would be an oil workers strike today in Nigeria. This strike has been called off at least temporarily. In other Nigerian news, nine Chinese workers kidnapped 12 days ago were released over the weekend. These two events could provide the impetus for a small selloff in crude beginning today but it’ll take warmer forecasts to really send crude into a tailspin.
  • Heating oil weighted degree days show a slight decline to 282 versus the prior week’s 287 which should yield a slightly smaller pull from heating oil inventories unless the refiners decided to continue to reign in utilization.
  • No New Picks Until Oil Hits $60

    I’d much rather miss out on the first 10% of a change in direction than try to pick a top or bottom. Phil of Philstockworld reminded me of my comments from January 17th: “Watch out for a potentially large bounce off $50.00.!!! If we don’t knife through it the bounce could be very painful so watch your puts.” I should have listened to myself more closely because I only added a few calls at the time. Man what a ride it’s been since then:


    The divergence between oil the energy stocks has started to crumble. Until the last couple of weeks oil had vastly underperformed the oily stocks of the XOI as depicted in the first graph below. The out-performance of the stocks can large be explained by:

  • Wall Street’s belief that any weakness in oil and gas prices was temporary at best.
  • Record buybacks led by Exxon Mobil (NYSE:XOM).
  • A generally rising equities market.
  • Recently, as oil took it’s almost mandatory bounce off $50 to its present level of $59 (up 14% in two weeks), the stocks managed to gain “only” 6% (see second graph below). This “divergence from the divergence” is not attributable to underperformance from natural gas, which also scored double digit gains since the mid January commodity bottom, but is instead I believe, attributable to rising forward multiples and an increasingly pervasive sense that commodities have rallied too far too fast so oil and gas prices will head lower when this recent blast of cold weather abates.


    The Organisation for Economic Co-operation and Development [OECD] Country oil inventories have been on an inexorable march higher. This list represents 30, primarily western, countries with large economies and trackable oil inventories. Demand may be rising at 1.3% annually but these countries seem willing to put more and more oil into salt caverns and tankyards at higher and higher prices instead of actually consuming it.


    Winter weather hangs on in the East, Heartland. HDDs came in at 258 for last week, up from the early read of 238 HDDs on a gas weighted basis. That means that last week was by far the coldest of the season for the gas heated regions of the country. I really don’t see how we avoid a 200+ Bcf pull this Thursday unless something on the industrial side of demand is truly broken. The CPC’s forecast for this week is another quite blustery 254 HDDs. These are just the sort of forecasts to make one run out and buy calls on Chesapeake Energy Corporation (NYSE:CHK), Southwestern Energy Company (NYSE:SWN) and Quicksilver Resources (NYSE:KWK) for a one to two week pop and I am considering it.


    These temperature forecast maps depict a slight change from ones over the last several weeks (there’s actually a splotch of red on them).

    While colder than normal weather continues to grip the eastern 2/3rds of the country a warming trending is stalled in the west. Could this be the end of Winter? Probably not but it will serve to limit gas withdrawals from the western region, a maybe slightly from the producing region in coming weeks. Texas is expecting a return to 70 degree highs which is actually a return to normal for our little slice of heaven.

    Since the western and producing regions have shown the biggest acceleration in withdrawals of late it would be better to see a return to more normal temperatures pushing further into the south before heading back for more puts on the energy group.

    Disclosure: Author has no position in the above-mentioned securities.