Natural Gas & Oil Energy Trend Advances to New Highs on Storm Hype and Gasoline Draw Down, Delaying Correction – on Borrowed Time

Technical Outlook

Last week we stated the corrective phase which took the market down about a dollar from recent highs was still in force and possibly to bring a challenge to $8.60 if prices didn’t rebound quickly back above $9.41 on close. We gave either scenario equal chance due to enhanced volatility. Prices did rebound, and quickly, with prices spanning an 80-cent range before settling above 9.41 on Monday. Confirming our short-term likelihood to re-ignite the up-trend if prices did not penetrate $8.60 within 2-4 sessions and the action also testified to our extreme volatility outlook. Looking ahead, volatility will continue at elevated levels, and today’s second failure to close above $10.00 after trading above the landmark is testimony to rally fatigue, and the market is showing signs of loosing momentum. Technical studies overall show an increasingly overbought condition. Under this chart pattern we expect an important failure soon near or below the existing high just above $10.00 for a rapid test of intermediate support at $9.40, and then a likely breakdown to $9.25 and then possibly $8.90 before more significant buying support emerges. Only a sharp momentum breakout back above $10.00 resulting in the first close above this key benchmark, would signal a bull continuance to then test $10.60 next, but would need to transpire in the next 2-3 sessions in order to combat the drag from bull fatigue in our opinion. Prices look more willing to fall back to support, under the current posture, in our view.

Fundamental Supply Update

Today the EIA announced a net injection of 60 BCFs that was comfortably above both estimates by Bloomberg and Dow Jones. It was also just slightly above our company call of 52-57 BCFs. Storage now stands at 2575 BCFs which is 27 BCFs less than last year and yet 136 BCFs above the 5-year average of 2439 BCFs. Prices quickly collapsed to session lows as the slightly bearish EIA news released a half hour after the opening only added to the main negative news of tropical storm Katrina’s concluded path as generally expected to spare the critical “production coast” of the Gulf of Mexico. Late reports before today’s opening indicate that while Katrina may likely pass through the Florida Peninsula and then re-emerge in the gulf and re-strengthen, its path is projected to then move to the Northeast away from key drilling platforms off Texas and Louisiana’s coast only to make landfall somewhere along Florida’s Gulf Coast north of Tampa all the way up to Pensacola. This “dodge of the bullet” had much more impact than an injection that was a few BCFs above expectations. With Baker Hughes reporting 1221 rigs pumping gas, down 9 from the previous week as August 19th, production continues to be viewed as precarious and still vulnerable to demand fluctuations. With the heat factor somewhat moderated in the second half of August, values will be hard pressed to sustain $9.50 much less $10.00 for any prolonged period, in our view, and that is why the “storm effect” now becomes so influential as we exit summer and enter the shoulder months of fall. Should Katrina actually bypass oil and gas infrastructure next week and then the tropics remain quiet for even a few days, and values could retreat quickly as most of the bullish news has already been inflated into pricing, and then some, creating a vacuum under the market. So far now and into next week, Katrina will be the dominant driver.

Concerning crude oil, this week’s EIA update and then Katrina, in that order of importance, were the prominent factors that impacted the market. The EIA release yesterday reported a slightly higher increase in crude stocks of 1.8 MBs than was anticipated leaving a total of 322.9 MB which remains well above the upper end of averages, along with an increase within expectancy of 1.4 MBs of distillates, mostly high sulphur (heating oil), also well above averages, while the only unexpected number was the sharp decline of 3.2 MBs of gasoline, almost twice what was expected, and again the headliner, as it leaves supply at the bottom end of the average range. This drove prices to a decisive close above $67.00 pb following the news as traders chose to focus on the only product that is in temporary short supply, and obviously ignoring the eminent passing of peak driving season this coming labor day weekend, because as up to now, gasoline demand has not subsided with usage running 1.6% above the same period last year. This seemed to catch traders off-guard, which ignited short-covering as market players expected more gasoline production after refineries came back on line from the numerous outages over recent weeks and some were also expecting demand to slow which didn’t transpire according to the numbers. With operating capacity holding at 93.4%, changing little from last week only to increase distillate production while slightly dropping gasoline production, it leaves a perplexing dilemma for the market ahead. It has been a product led rally all year as crude stocks have been more than adequate, and this fact is even more evident as the SPR (Strategic Petroleum Reserve) is now full, over 700 MBs, and with distillates also well above average, it puts all the emphasis on the gasoline draw downs. Considering how quickly the refineries were able to arrest an earlier shortage in distillates by prioritizing output of that product over the past six weeks or so, one must consider the impact on prices if refineries now temporarily focus attention on gasoline production while at the same time demand winds down as driving peak season ends. This could quickly put all three commodities at or above average supply, and at a time when gasoline demand is anticipated to subside. Prices could rapidly do the same. With crude now suspended at all time, stratospheric highs above $67.00 on storm hype, and geopolitical tension overseas. It may only take the storm disappointment of Katrina sparing the rigs, or a small indication next Wednesday of a refinery adjustment to higher gasoline output, to trigger a rather sharp collapse in all petroleum values. Next, let’s now take a brief look at weather as Katrina takes center stage, and due to a power outage here in our Hollywood office I was unable to download my normal WSI emailed update.

Weather Outlook and WSI Overview

Recent storm updates and an update from WSI this afternoon indicates that Katrina would make landfall just south of Ft. Lauderdale as a Category One Hurricane of 65-75 MPH winds and then progress across the Peninsula, likely to weaken to a tropical storm, and then re-emerge in the southern Gulf of Mexico only to quickly gain strength back to hurricane status, and then is expected to move north, northwest targeting landfall in the northern Florida panhandle to as far west as Mobile. Concerning temperatures an early cold front from the west will provide some heat relief briefly in the Midwest and parts of the Northeast early in the week. Texas will remain above normal with temps above 90, while peak temps in New York and parts of the upper Midwest and Great Lake states ranging from the 70s and hitting 80s and 90s at max later in the week.

Conclusion

Natural gas is still in a clearly defined up-trend and recently re-ignited the bull wedge after a sharp rebound back above $9.41 on Monday closing over $9.50. However, the market is exhibiting overbought technical signals, and with today’s second retreat from the key $10.00 benchmark after trading above it, we see prices highly vulnerable to a sharp decline near-term. Storm disappointment should be confirmed early next week as Katrina is expected to exit the Gulf in the northern Florida gulf coast comfortably east of key drilling operations. The heat index seems to be well factored into current values, and with injections expected to rise in coming weeks should not provide enough strength to sustain $10.00 in our view. Only a sharp momentum breakout back upward yielding a close over $10.00 would delay the correction and suggest a test of $10.60 near-term but would need a new storm threat to support this scenario in our opinion. Otherwise we expect prices to fall soon back to test $9.40 and then $9.25 with a possible washout back to $8.90 before significant buying surfaces to stem the decline.

Concerning crude oil this past week has provided a lot of bull hype and fear ammunition for traders to artificially inflate values up to new highs between $67.50 and $68.00, the intra-day high. There were missiles fired at U.S. ships in the Jordanian port of Aqaba, a short-term evacuation of workers from a platform in the North Sea reported by Shell, shutting in 10,000 BPD, the brief halting of production in Ecuador due to civil unrest forcing PetroEcuador to shut 200,000 BPD production temporarily, and finally a morning power cut in Basra halted export of 1.5 MBPD from southern Iraq. However, none of these occurrences had any real lasting interruption to supply, yet managed to impact perception and help fuel the increase to the existing net long, speculative position to crude futures which stood at 40,395 contracts as of August 16 th . We feel the biggest impact headline was the larger than expected drop in weekly gasoline stocks, which is now factored in, and thus the whole complex is extremely vulnerable as the 8 th consecutive gas draw down has exaggerated values already. This will likely correct itself as refineries are expected to now focus on gas output due to stretched profit margins, extreme political pressure, and existing below average supply. If signs of demand destruction emerge, as some consumption curtailment due to recent unpleasant price hikes is already anticipated, then a more accelerated and dramatic sell-off could occur. Of course, current momentum could still carry values up briefly to $69-69.25, beforehand, but that would only precede a more violent collapse back to key support at $63.80, and then $62.90, in our opinion. We feel in order for prices to move on up to challenge the lofty $70.00 level that many suggest, it will take a new unexpected event such as a new storm to directly target the key Oil production areas of the U.S. gulf, or a major Oil interruption to supply, more than a threat, in one of the “hotspots” overseas, to extend this rally attempt further. This is due to traders running out of fundamentals that are not already factored in, heavy U.S. existing crude stocks, and a tired market that is technically overbought and losing momentum at the $67.50-68 level, in our view.

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August 25, 2005

United Strategic Investors Group

Guy Gleichmann, President

1926 Hollywood Blvd Suite 311
Hollywood, Florida 33020

September 1, 2005

www.strategicinvestors.us