< --OT-- >Taurus Lucretious: Winter of Discontent ( Barron's )
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Winter of Discontent Barron's On Line Feb 15, 1999
No recovery in sight for heating oil
By Cheryl Strauss Einhorn
How much more downside is there in the heating-oil market?
Richard Redash at Prudential Securities thinks already depressed prices could sink another three cents a gallon in the next two weeks. That's a 10% slide by month's end, given that current prices are 30 cents a gallon, their lowest in more than a decade.
"I think prices will go down to the 27-cent range before the active March contract expires," says Redash.
Unusually warm winter weather has been this year's culprit. Last winter was the warmest the U.S. had seen in years. But meteorologists from the National Weather Service say this season the number of days Americans need to turn on the heat in their homes is running 10.5% below normal, compared with around 5% last year.
Temperatures have been running above normal not only in the U.S., but on the other side of the Atlantic, as well. That has left a record surplus overhanging the heating-oil market: Supplies are 29 million barrels above the five-year average. In fact, Redash predicts that by the end of the heating-oil season on March 31, stocks will still stand at a level higher than where the market usually begins the season in October. It hasn't helped that demand from Latin America has suffered, owing to financial turmoil in Brazil and elsewhere on that continent.
Part of the problem traces to the oil refineries, which despite the glut have yet to scale back production much. In fact, refineries are still running at more than 95% of capacity, in part because until last week, refining margins were positive. In other words, refineries were still making money.
On Wednesday, for the first time in three years, margins on heating oil in the Gulf Coast went negative; based on their average variable costs of nearly 25 cents a barrel, refiners on Wednesday found themselves losing between nine and 11 cents a barrel -- losses that held at that level through week's end.
Why did the margins collapse? Because there is simply no place to put the heating oil. Despite the losses, though, refiners' margins need to remain in negative territory for a number of weeks before forcing significant cutbacks, thanks in part to the costs of shutting down operations.
As a result, with nearby heating oil futures sinking, the market's forward price curve has steepened significantly. Hence, beyond simply selling nearby heating-oil futures to gain from declining prices, investment bank Goldman Sachs is recommending that traders short the August 1999 crack spread between both heating oil and gasoline against crude oil. That is, for every barrel of August crude oil that is long, one should short half that amount of August heating oil and half that amount of August gasoline.
Essentially, the firm thinks prices of supplies for future delivery are substantially higher to pay for the cost of storage, but that future prices must come down as they become the active or current month's contract because it is unlikely the product surpluses will be erased in the near term.
The current crack spread commands $1.56; looking out into August, that same crack spread stands at $3.20. The average per month conversion between crude oil prices and those of heating oil and gasoline is 25 cents a month.
Why does the firm recommend the gasoline trade as well as the heating-oil trade? Because with no place to put the heating oil, refiners are beginning to switch their plants over to gasoline production. Yet the peak season for gasoline demand is still a few months away. By beginning to ramp up gas production early, refiners are setting up the gas market for a collapse like the one that has now hit heating oil and that felled crude oil just months ago.
Moreover, even by shifting to gasoline, refiners can't help but produce some more heating oil; they cannot make one product without making the other. That's the rub.
Last year refinery operations ran strong because of robust gasoline demand. As a result, heating-oil stocks continued to build in the off season even after 1998's warm winter. It seems that this year's market is destined to repeat that cycle. This time, though, "it'll be even worse for heating oil than last year," says Redash.
"We're going lower," he says, and he advises selling into any price strength. He thinks that all during spring each successive nearby contract will go down to 30 cents a gallon. "There isn't any sign of a supply shock coming, and barring a war, not even a few days of cold weather could save this market now."
Key Commodity Indexes
CRB Group Indexes 2/12 2/05 Yr. Ago
CRB Futures 186.77 190.50 231.61
Industrials 178.17 183.80 208.42
Grain/Oils 166.21 171.59 215.53
Livestock 220.40 221.60 238.17
Energy 128.52 130.22 173.88
Precious Metals 245.33 241.97 270.32
Barron's ~ Bridge Telerate
You said : thanks for the civil question,
"good" stock is a relative term subject to the whims of the mkt.
Value always has a way of popping up in the end. That's why guys like W. Buffet don't chase the high flying trash and buy the stuff nobody wants and then hold it for a long period of time until the masses are chomping at the bit to buy it, then they dump it.
I think the drillers have one more panic move down to be honest, but I will be buying there.
It is funny, that this board contiually makes fun of my invetsments in Japan and shows how little they know. Not only has the Japanese mkt performed quite well since this Summer but the YEN has crashed up against the dollar giving all Japanese stocks from a US perspective a HUGE move and will move alot higher as the dollar continues to fall against the Yen. Pull up the charts... (MBK, NTT, APF, JOF, JEQ are just a few that I own).
Value (like Japan) moves eventually and later once the masses figure out that there's a bull mkt it peaks soon thereafter.
gold is another example of this, after bottoming in August, it has done quite well, but nobody knows about it yet cause the bull is so young (the masses probably won't become aware of its bull mkt for a while much like they haven't of silver's untuil recently which has been going on for 2 yrs now--- recall when Buffett bought silver last yr, everyone thought he was a moron... hohoho.. who's laughin now?)
Gold is readying for a MAJOR move next week, and it tends to crash-up rather quickly.
DBRSY is another favorite of mine that I bought this Summer when nobody wanted diamonds. Take a look at it.
If you buy dirt cheap stocks in good businesses, they eventually turn.
-Lucretius
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