The Energy Report for Monday, July 12, 2010

The Bulls Have To Earn Their Keep

This week oil bulls are going to have to earn it. Last week oil rallied to a renewed sense economic optimism. Risk appetite came as gold rallied and the 10 year yields went back to above 3%. We saw the industrial metals rally and we seemed to finally shake off the weak jobs environment in favor of this sense that gosh oh golly things just have to get better. Or maybe we figured that things just cannot get worse.

So now welcome to earnings season. You know, put up or shut up time for all of the stocks. To follow through on that guided or misguided optimism this week's earnings season will have to keep the momentum going. Oil bulls will desperately need those numbers to be good. As is tradition, earnings season will start up and the commodity related stocks such as Alcoa and traders are hoping that they beat expectations. If they don’t set the right tone and unless the stocks stay strong, oil will start focusing again on a glut of supply.

Oil bulls need the market to focus on anything other than supply. With no tropical storm worries it’s all about earnings, not to mention of course the stocks and the dollar, for oil from this point forward. Of course if the earnings come out like I think they will it will be very mixed. Some will come out better than expected and some will come out worse leading to oil staying pretty much in a tight trading range. This will keep us playing the swings as well as option strategies like condors and butterflies.

You have to take what the market is giving you. Because of this trading environment and because of the recent market action the Energy Information Agency last week kept their forecast for oil unchanged. The EIA projected that the West Texas Intermediate (WTI) spot price, which ended June near $76 per barrel, will average $79 per barrel over the second half of 2010 and $83 per barrel in 2011. For gasoline the EIA says that they expect regular-grade motor gasoline retail prices will average $2.80 per gallon during this summer's driving season (the period between April 1 and September 30), up from $2.44 per gallon last summer. 

The summer gasoline price forecast is up only slightly ($0.01) from last month’s Outlook, but $0.12 per gallon lower than the EIA forecasted in April, when oil prices were significantly higher. For traders this present challenges and opportunities. It is important to realize the type of market you are dealing with. This is unlike past years where the market had a distinctly bullish or bearish flare because this market will be a little of both. You cannot marry one side of the market.

As for natural gas the Energy Information Agency says that the Henry Hub spot price which averaged $4.80 per Million Metric btu in June was $0.66 per MMBtu higher than the average spot price in May.  The IEA forecast for natural gas prices in the second half of 2010 averages $4.68 per MM Btu, $0.32 per MMBtu higher than last month.  The EIA says the risk of hurricane outages and the projected reduction in drilling activity combine to strengthen prices through the year. A small decline in U.S. production alongside increased consumption leads to higher prices in 2011; the projected Henry Hub spot price averages $5.17 per MMBtu. 

The EIA says that uncertainty over future natural gas prices is lower this year compared with last year at this time. Natural gas futures for September 2010 delivery for the 5-day period ending July 1 averaged $4.77 per MMBtu, and the average implied volatility over the same period was 53 percent.  This produced lower and upper bounds for the 95-percent confidence interval of $3.16 and $7.18 per MMBtu, respectively. 

At this time last year the natural gas September 2009 futures contract averaged $4.00 per MMBtu and implied volatility averaged almost 76 percent.  This rendered the lower and upper limits of the 95-percent confidence interval at $2.25 and$7.14 per MMBtu. Make sure you are getting our latest buy and sell points as well as option plays. Just call me at 800-935-6487 or email me at pflynn@pfgbest.com to open your account. Also start your week out right by tuning into the Fox Business Network where you can see me every day! 

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