Oil Musings

Econopundit has an amazing chart of historical oil inventories here:

Oil Inventories


Apparently oil inventories aren't too far off from their all-time high, and this inventory could take 2 or 3 years to work off. If the high inventories aren't caused by a slow economy, just imagine what a 2 or 3 year glut of energy supply could do for the economy and the stock market. It's interesting that now OPEC members are seeking to reduce production. I think that OPEC learned a valuable lesson from the past years' energy price spikes. That lesson is that oil can stay above 50 bucks or so, without causing the world economy to collapse and immediately cause a drop in demand which lowers prices. Just a few years ago who would have thought that oil could hit 70 without starting a recession?

Now I know almost nothing about the global politics or macro-economics, so I'm going to engage in some wild speculation and assume some facts where I have no idea if they are really true or not. I wonder if the parts of OPEC that are pushing for production cuts might be primarily those dominated by Venezuela and Iran. Iran and Venezuela's reserves are declining, while at the same time due to mismanagement, their ability to find and extract new reserves is almost non-existent. They both need money very much in the short-term to maintain their regimes. Iran needs money for it's military build-up and to pay for the Hezbollah/Lebanon fiasco. Chavez needs a constant flow of money to give away as hand-outs to the poor and to pay off his cronies in order to maintain his power. These major oil producers need oil to stay high in the short term as they need cash-flow right now.

On the other hand you have nations like Saudi Arabia, Kuwait, and Dubai who have lots of oil, plus advanced oil exploration capabilities thanks to their partnerships with western corporations. These countries are basically financially sound at 25 dollar oil or at 50 dollar oil. Although 50 dollar oil doesn't cause the global economy to collapse it does make a lot of exploration, alternative energy, and conservation economical that wouldn't be at even 30 dollar oil. I wonder if these OPEC members would prefer if oil were lower. Over time 50 dollar oil is going to reduce their power in the global market as substitutes are found in the rest of the world. Since these nations probably have more marginal supply than the likes of Iran and Venezuela they probably hold enough production power to influence the price of oil moreso than Iran and Venezuela.

Although I generally think conspiracy theories about various "evil factions" manipulating the price of oil to influence the US economy and Elections are stupid....I'm going to indulge and be stupid anyway....forgive me: It seems to me that the leaders of the Sunni nations such as Saudi Arabia, Kuwait, and Dubai would prefer that the US have a strong military presence in the Middle East, despite what they might say publicly. We are the only thing standing between them and the Shiites in Iran and Iraq now that Saddam Hussein is gone. They need us there to keep the Shiites contained.

The leaders of Saudi Arabia, Kuwait, and Dubai must know that the Democratic leadership in Congress favors withdrawing from Iraq and appeasement of Iran, so I wonder if they might be pushing oil prices down in order to encourage a Republican victory in the '06 elections? If anyone really has the ability to manipulate the global oil markets in such a way, it would be these guys who could actually pull it off.

Is the drop in oil a sign that China's economic bubble is beginning to pop?

It seems like I remember it said by many analysts and commentators who were/are bullish on oil that U.S. demand doesn't matter so much anymore. I think the argument is that the price of oil is driven by marginal demand in China now-a-days and that this is why oil has to go to $100/barrel or whatever, because they will buy all excess inventory available to fuel their "unstoppable" economic expansion. Now, I am noticing in the articles I read,that the recent decline in the price of oil seems to be attributed by the analysts to U.S. factors...stuff like the U.S. economy is slowing, U.S. consumers are conserving, etc.. China doesn't seem to be mentioned that much anymore. I wonder, though if the original idea is correct, and if so is this an early sign that the Chinese economy is in trouble? (FWIW, I guess I'm currently fading the oil move since I'm long OIH Jan 07 135 Calls.)

Stock Prices and Terror

Does today's thwarted terrorist attack remove the implicit terrorist discount from the US equities markets? I occasionally see it said that ever since the attacks of 9/11, that the market prices in the threat of terrorist attacks. This means that all else being equal, stocks trade at a lower price than they otherwise would, because they are pricing in the threat to company profits resulting from future terrorism.

If this was intended to be the next big follow-up to 9/11 then it took them almost 5 years to put it in place and they were completely stopped by the authorities. Does this give us at least another 5 years before we have to worry about another big attack?

Pour some out for my dead homies...

James Altucher had some interesting comments in the realmoney.com columnist conversation today. He says that volatility sellers are getting creamed and that index put selling hedge funds were getting liquidated today. The resultant put-buying and associated hedging is pushing the market down, and when those liquidations are complete (maybe tomorrow!) he believes the selling may stop. As someone who has been doing their best to provide some small liquidity to those buying July index puts since the middle of last week, I sure hope he's correct, otherwise I'll be joining my put-selling brethren in some forced margin liquidations of my own!

Bernanke doin' his best to make you and me poorer...

I think it's interesting how when Bernanke's appointment was announced many people characterized him incorrectly as an "inflation dove" based off of a speech he made one day where he said something to the effect that we don't need to worry about deflation because the Government "owns this thing called a printing press" and can "drop money out of helicopters" if necessary to fight deflation. It seems to me in retrospect that those comments were extremely hawkish. What he was really telling us at the time was that he doesn't take deflation seriously as a threat at all, and is only going to be focused on inflation concerns. I get the sense that many commentators still think he is really a "dove" deep down and that he will return to his true "dovish" nature once he is done "flexing his muscles" to get some "hawkish street-cred" as a new fed-chair.

In less than a month trillions of dollars have disappeared from the economy through the stock market decline. At least as much wealth has probably evaporated in the real-estate market as well, but that won't be fully appreciated until later due to the relative illiquidity of the real-estate market as compared to the stock-market. Sounds like some serious deflation happening in this economy here...doesn't it? Unfortunately, Bernanke won't see any of this because he evidently doesn't believe in deflation and is going to be watching out-dated inflation measures that have oil prices as an input...but alas there is nothing Bernanke can do to lower the price of oil other than destroy the economy. The stock market seems to think that this is exactly what he is going to do.

Mark Cuban is a Whiner!

Mark Cuban has a great post on his blog today. I imagine that one of the best things about being a billionaire is that when some loser calls you a whiner you can always respond like this:

http://www.blogmaverick.com/entry/1234000210073685/

My favorite part is near the end where he describes a non-whiner as someone who "has so little distaste for watching people around him get hurt, he does nothing." I think Mark Cuban is writing a little tongue-in-cheek though. It's one thing to whine, it's entirely another to whine and actually do something. It's the former class that gives whining its bad connotations.

Murphy's Option Law: A Stock will make its big move when you are not net-long contracts!

So I have been playing a simple counter-trend system lately using options. I've been playing it Telab style by using the system's signals to build butterflies with extra wings. Basically it works like this. When the system signals a stock purchase, I would sell a bull put spread with an extra long put (This is actually called a backspread). Then, when the system signalled a sale, I'd sell a bear call spread and buy an extra long call. (Again this is really a backspread) Sometimes I would buy the extra options at the same strike and sometimes I would buy them a little further out of the money. At first, I was very disciplined about buying those extra options every time, but lately I had began to feel like a sucker giving up so much of my premium to buy those extra long options so I had stopped buying them, and was simply building butterflies without the extra wings. This leaves me protected from "black-swan" events, but I was no longer positioned to profit from them.

Well, I had my first really big moves (since I started using this system) in 2 of my positions today...and whatdayaknowit...of the 20 or so positions I had put on using this system, they were in 2 of the 4 where I didn't have those extra wing options! Niether of these were "black swan" moves, but one of them at least was big enough that it would have really made my month if I had purchased those extra calls. The stocks were WFMI which was up 12% and EXPD which was up almost 20%. For the WFMI position, the system had not trigered a sale since the initial purchase trigger so I had not finished building the butterfly and I went into this move with a deep in the money bull put spread,. There was a nice, but limited profit from this move. If I had completed the butterfly with extra wings I probably would have not made much money from this position or taken a small loss, since the 12% move, although large, wasn't enough to produce much of a profit from an extra out of the money call.

With the EXPD butterfly, I definately would have made good money from this position, on the order of several hundred percent return on the capital risked if I had purchased those extra wings, instead of taking a limited loss like I did. As it is, the pnl from both the WFMI and the EXPD positions about cancelled each other out today.

Assuming, I continue to use this system after May expiration, I think I will modify the strategy like this. When I enter the vertical spreads, I will move an extra strike out of the money, and always buy 2 of the long option part of the spread. (Buying 2 of the long options changes the vertical spread into a backspread.) This way I won't have to give up so much premium to buy the extra wings, which will make it emotionally easier to always buy extra wings. This will increase the amount of capital at risk however, so I will have to take less of the trades signaled by the system. This is not a problem, though, because I have allready become more picky about which signals I trade. I would have made money from these moves today (taking a small loss on WFMI, while making large profits on EXPD) had I been using this modification to the strategy.