Natural Gas Leads Energy Complex Higher

Natural Gas Leads Energy Complex Higher as Production Lost Peaks at 80% While Rig and Platform Damage from Rita may Prove to be Severe

Technical Outlook: Last week we stated that the technical picture, although very bullish, had once again taken a back seat to the dominance of a key fundamental event, that being hurricane Rita, and that this would be the main price driver looking ahead. Now that the storm has passed, and the fundamentals are becoming more apparent, the technical picture will come back into play and gradually become more influential on prices in the days ahead in our opinion. Looking closer at the current technical picture, although still being marginalized by the importance of assessing the damage left in the aftermath of hurricane Rita, the overall posture of the market is still quite bullish with indicators such as relative strength, momentum, the MACD, along with several channel oscillators declaring a continued upward bias to pricing ahead. Meanwhile, stochastics and some indicators are obviously giving overbought warnings. Under the current pattern we see a minor resistance now established from the price range of the past two sessions set at $14.58 up to $14.80. Look for support on pullbacks first at $13.80 followed by $13.50, with a more critical and pivotal support at the deeper level of $12.70, which should the market retreat to this level would attract more buying interest, in our view.

Today the EIA reported an injection of 53 bcfs that was well below both survey estimates by Bloomberg and Dow Jones of 66 and 63 bcfs respectively. It was also six lower than the closely watched ICAP estimate of 59bcfs, and yet it was right in line with our company call for 52 – 57bcfs. The bullish implications on pricing quickly elevated values to the session high of $14 .58, a rally of about $.30 before nervous long’s and profit-taking gave way to a sharp sell-off and no doubt a characteristic of volatile, thin trading conditions. Still, values managed to shore up by the close and posting still another positive and all-time record high close for a spot month which is now in November futures at $14.196. Storage now stands at 2885bcfs, which is now 116bcfs below last year at this time and yet only a meager 68bcfs above the five-year average of 2817bcfs. Looking ahead with the market needing a steady and consistent injection of at least 63bcfs per week for the remaining five weeks of the injection season to reach the psychological 3200 benchmark , and with the MMS reporting little improvement from yesterday with 79.8% of gas production still off-line, it has now placed supply generation in a bullish race against time. Yesterday’s unprecedented price surge that literally stole the headlines away from the petroleum complex whereby the October expiration settled at a level that was almost 40% higher than any previous high close prior to this year after hitting an intraday peak price of $14.80 and that was almost 50% higher than the markets previous all-time high close outside of 2005 of $10.10. The price move yesterday confirmed almost to the penny our prediction stated in last week’s fundamental update whereby we stated prices could easily exceed $13.80 to then challenge the price bracket between $14.50 and $15 per million BTU which is exactly what transpired on the expiration of the October futures hitting an intraday peak of $14.80. This landmark volatile session whereby prices vaulted over two dollars at one point were the result of the combined influence of panic short covering from traders that obviously expected some length to come out of the market in sympathy with crude oil which gave up about 40% or $.80 of its gains in the last hour of trade, and when this failed to transpire were forced to buy out of their short position, along with the bullish undertone of about 80% production shut-in and the continued force majeure declared by the Henry hub extended into the Nymex October delivery. The combination of the unrivaled assault that was inflicted upon the critical production oil and gas infrastructure of the Gulf of Mexico by two major storms which resulted in the complete shutdown of the Henry hub made for a volatile cocktail that was too much for the shorts to swallow. The fact that the combined losses from the two named storms has already reached 188bcfs which in only five weeks surpassed the production that hurricane Ivan vanquished over a five-month period of time between 2004 and 2005 paints a graphic picture of the new mile marker that has been set of severe and detrimental impairment to the nation’s ability to produce a vital fuel that makes up over 25% of the countries Energy requirements. This also comes at the worst time just ahead of winter when over 55% of residential America depends on natural gas for its heating needs. This makes the immediate progress or timely lack thereof to the recovery efforts of restoring much-needed production from what was considered to already be a labored endeavor prior to Katrina or Rita whereby values had already escalated to a never before seen height of almost $10pmbtu during a summer, vital as to the potential for further price spikes that will no doubt shock the industry and further plague the US consumer. Some of the key challenges that face the restoration efforts besides the shutdown of the Henry hub are the fact that the Colonial pipeline remains at about 55% capacity along with the fact that over a dozen gas processing plants are off-line due to flooding, lack of supplies, inability to move stored liquids, and safety precautions, which continues to underpin the up trend to prices.

Concerning crude oil refineries from Beaumont and Port Arthur Texas along with Lake Charles Louisiana are still not operating and is responsible for the loss of about 1.7 million barrels per day of refined products. This includes the Citgo refinery at Lake Charles responsible for 324,000 barrels per day, Conoco Phillips refinery at West Lake Charles with the capacity for 239,000 barrels per day, the Exxon Mobil at Beaumont capable of 348,000 barrels per day and the largest of the area, along with The Shell Motiva joint 285,000 barrels per day and TotalSA’s 233,500 barrels per day refinery at Port Arthur along with the Valero 255,000 barrel per day refinery also at Port Arthur. In total this represents a major amount of petroleum production that continues to confirm the extreme and debilitating plight of the US Energy production shortfall that has been the result of these two devastating hurricanes. MMS reports that the amount of current platforms and rigs that still remain evacuated represents 59.95% of the 819 manned platforms and 26.87% of the 134 rigs in the Gulf as of Thursday afternoon. Seven refineries in Southwestern Louisiana and southeast Texas remained closed due to power outages and or damage representing a total of 29% of the refining capacity of the existing 144 US refineries with a maximum capacity to refine 17 million barrels per day of petroleum. Also 9 out of 12 gas and oil pipelines that move gas and oil onshore remain shut-in or are operating at subnormal capacity as of Thursday morning. According to ODS Petrodata, an industry information source, 13 rigs are seriously damaged or destroyed, and while platform assessments are still pending this initially represents 10% of what is contracted, being out of service for various lengths of time or permanently, which is a significant amount of production when considering we are soon approaching peak petroleum demand this winter.

A hurricane Hunter aircraft found the potential for another tropical depression to be formed near the Cayman Islands. However conclusive data and information have yet to be attained as to the further development into what could become tropical storm number 18 which would later be called Stan. Another flight is scheduled to determine if conditions favor further development on Friday. This situation will obviously hold priority and will be monitored closely as conditions seem to be near normal with regards to the main Energy consuming regions of the country.

Natural gas will continue to be the price leader of the Energy mix considering that there are no backup reserves to the already considered precarious storage level now that almost 80% of production is still off-line. This will continue to be the case unless an unusual amount of gas production is suddenly restored such as from the two Dynegy facilities at the Venice and Yscloskey gas processing plants or the Toca facility which doesn’t look likely at this point. With the exact gas production shut-in at 7.97bcfpd which is equivalent to 79.97% of daily gas output in the Gulf reported by the MMS, the rate of supply in proportion to anticipated demand looks desperate at best. With yesterday’s technical break out with spot prices breaching the $14 per million BTU benchmark for the first time in the market’s history certainly has elevated the confidence of determined bullish funds while putting panic into the hearts of short traders and industry constituents that by necessity are forced to buy at these stifling high prices to meet their physical needs. Looking ahead the potential scenario becomes only more bullish when considering not only the positive technical posture that encourages the anticipation of higher prices but also the aggravating potential of another named storm possibly entering the vulnerable Gulf of Mexico in the remaining approximate 30 days to the season. The current disorganized system being monitored in the Caribbean is a sobering reminder of the reality of just this nightmare scenario. Yesterday’s violent and sudden price advance over two dollars at the intraday high was an open warning and declaration of the extreme risk of stepping in front of this Energy freight train and shorting it while praying for it to suddenly stop and backup in its tracks! We anticipate, due to the recent price break out and the markets’ sensitivity to the upside that any single significant bull news or combination of factors such as a sudden petroleum rally which is quite possible due to the strength in gasoline futures or the sudden announcement of an unexpected further delay to critical gas production being restored, could trigger a strong continuation of the recent price advance elevating values above the key $15 benchmark to be quickly followed by an escalation to prices between 16 and $17 per million BTU! Of course nothing could cause prices to break out and advance to these higher levels quicker than the discovery of another storm system heading for the Gulf! At this point the market seems, and rightfully so under current bullish fundamentals, to be unwilling to give up much ground with supports below the market first at $13.80, down to $13.50 with a more critical support at the deeper level of $12 .70 whereby if attained stronger buying would emerge in our opinion. There are too many bullish “ what ifs”, such as the yet to be determined undersea damage to critical pipelines due to sediment shift from the storm surge, that could further delay and impair critical supply being transported from offshore installations to onshore processing facilities.

FUTURES AND OPTIONS TRADING INVOLVE RISK OF LOSS AND MAY NOT BE SUITABLE FOR EVERYONE.

CONSENSUS September 29, 2005

United Strategic Investors Group