Let’s start with Oil and the commitment of traders (COT) report. Note that from 2002-2010 commercial traders cumulative position ranged from short 100K contracts to long 100K contracts. In early 2010 their net short position dipped below 100K contracts before moving closer to neutral around mid-year. Since then, speculators (non-commercials) have gone furiously long the market as the commercial net position has surged to over 300K contracts. I looked at historical charts and this position is a record.

Not only the professional speculators who are long energy so too are the retail players. Our evidence is the Rydex data and chart from sentimentrader.com. This shows fund flows in Rydex’ Energy Fund. The middle column shows assets in the fund and the bottom column shows assets in the fund relative to all other sectors. Needless to say, these metrics have exploded in the last six months.

Keep in mind that sentiment follows the trend. More and more bulls means higher prices. Yet, when there are too many bulls around or too much money going into a market, it poses a short-term risk and creates an environment that is ripe for profit taking. One reason we like energy is because it often peaks after the stock market. For example, if the market peaks in April or May then energy could peak in August or October.

That being said, it is time to be cautious on energy in the near-term. We know little about geopolitics but we do know that there is record speculation in the Oil market and that will end at somepoint. Does it end at $120 Oil or $90 Oil? We don’t know but we do know that there is huge risk in the market with a record speculative long position. Meanwhile, tons of retail players have already piled into the shares and could move out on any sudden change in the situation in the MidEast.

For more analysis and forecasts, consider a free 14-day trial to our Commodities service.

Good Luck!

By Frank Holmes

Read more: Oil’s March Madness a Boost for Refiners http://dailyreckoning.com/oil%e2%80%99s-march-madness-a-boost-for-refiners/#ixzz1FzlZO1nK

By Addison Wiggin

03/04/11 Baltimore, Maryland – Crude oil topped $103 this morning.

The last time oil was this high was Sept. 26, 2008 – the last trading day before the US House rejected the first bank bailout bill. Wall Street then threw a snit and slashed 777 points off the Dow in one day.

Good times.

There doesn’t appear to be any overt reason why the price popped today. But beneath the surface, we see a series of ominous developments from Saudi Arabia, the world’s No. 1 oil exporter. Events that could make $103 oil seem as quaint as an 8-track tape left in an abandoned car for the last 40 years.

First, a little background. World energy demands – and, by extension, traders in the market – rely on something called “spare capacity” or producers’ ability to jump-start new oil production within 30 days and keep it up for at least 90 days.

If you listen, you’ll hear it on the tip of the “official” tongue. Yesterday, for example, Treasury Secretary Tim Geithner assured Congress: “It’s important to note that there is considerable spare oil production capacity globally.”

“Spare capacity” in the oil market is directly analogous to the bag of tricks Ben Bernanke alluded he’d dip into when the time comes to unwind the Fed’s balance sheet.

For better or worse, most of the “spare capacity” burden falls on Saudi Arabia. Saudi princes claim to be able to goose production from 9 million barrels a day to 12 at the drop of a hat.

Never mind that they’ve never done anything like that before, even when oil ran up from $25 to $147 a barrel between 2003-08. The official line – and, therefore, the oil market – still believes it’s true.

But for how long? This chart from Morgan Stanley, analyzing worldwide demand estimates, suggests “spare capacity” will be tapped out in two short years.

Even by conservative demand assumptions, “spare capacity” disappears by 2013…

As fighting was getting under way in Libya a week ago, Saudi Arabian oil officials got on the phone to the International Energy Agency (IEA). They’d just boosted their daily oil production from 8.6 million barrels a day to 9 million. They wanted the world to know they could step in with the “spare capacity” to replace Libyan production.

Oil prices dropped in the final half-hour of trading.

Amazing, isn’t it? Saudi Arabia’s stated reserves are 259 billion barrels. Which is what they were last year…and every year going back to 1980.

In his book Twilight in the Desert, the late Matt Simmons, a gentleman with whom we shared an editor at John Wiley & Sons, found ample reason to cast doubt on official Saudi figures during the previous decade. WikiLeaks made public last month that a senior official from the state-owned oil company believes Saudi reserves are overstated by 40%.

And yet the market responded to what was effectively a PR campaign by the Saudi princes.

“There is in fact good reason to think that the Saudis are producing 9 million barrels a day,” says author Steve LeVine, writing at Foreign Policy, “but reasonable doubt that they went up to that level just last week in response to Libya.”

More likely, they boosted production some time ago to help meet domestic demand.

“If they were producing that much then,” LeVine says, “it does not necessarily prove that they can raise their production now, neither for the many months before full Libyan production returns to the market.”

The Saudis have also made public plans to start injecting carbon dioxide into the world’s largest oil field, Ghawar, no later than 2013. CO2 injection is what you do when an oil field starts yielding progressively less oil. It gooses the output…for a little while.

The plans come as no surprise from the Saudis, given Ghawar was discovered in 1948.

Even if the Saudi princes are telling the truth about their spare capacity, it all goes bye-bye in two more years. The fact that they’re resorting to complex and costly new tactics to keep the world’s largest oil field creaking along doesn’t exactly inspire confidence.

Bottom line: “Saudi Arabia can’t make the shortfall from Libyan supplies,” says commodities investing legend and Vancouver veteran Jim Rogers. “They’ve said in the past that they can increase production, but they can’t.”

Addison Wiggin
for The Daily Reckoning

Read more: The Truth Behind Saudi Arabia’s “Spare Capacity” http://dailyreckoning.com/the-truth-behind-saudi-arabias-spare-capacity/#ixzz1FnpAPZZf

Last week’s oil surge saw crude oil prices eclipse the $100-a-barrel level in New York and $120 a barrel in London. In a brand-new research report – a Mideast crisis update – Bank of America Corp. (NYSE: BAC) analysts said last week’s market reaction was the eighth-largest supply shock since 1980.

“More worryingly, with other countries like Algeria, Syria, Yemen or Saudi Arabia scoring highly on social discontent, the risk of continued tensions in the region remains high, in our view,” the analysts wrote.

And those comments don’t even include the Sultanate of Oman, the country located on the southeast coast of the Arabian Peninsula that last year exported about 860,000 barrels of oil per day – compared with about 1.6 million a day from Libya.

Oman Sultan Qaboos bin Said has ordered the hiring of 50,000 people in the wake of weekend protests that resulted in the death of one person and the injury of 11 others in that country, according to reports from Oman’s state-run news media. Oman is the region’s largest oil producer outside the Organization of Petroleum Exporting Countries (OPEC).

In the face of this kind of widespread uncertainty, when you ask analysts for their ideas on how we can maintain an oil-flow balance, most reduce it to a supply equation. If a certain amount of normal deliveries is suddenly withdrawn from the market – say, for example, the 1.6 million barrels a day produced by Libya – what is the remedy?

You have to look for other readily available sources to pick up the slack.

As we reported to our Oil & Energy Investor subscribers late last week – ahead of the mainstream news reports – the Saudis have agreed to replace the volume from Libya that had been lost to the market (actually, that had been lost to Europe, since 80% of Libyan exports move there). Saudi Aramco, the Saudi-operated venture that’s the world’s largest state-run oil company, pledged to move 700,000 barrels into the export flow immediately.

One thing about the Saudis: When they say “immediately,” they are acting with the same urgency that the word is meant to convey.

With roughly 2.5 million barrels per day excess capacity of physically available supply, that can be done in a matter of hours from Saudi fields – which translates into a few days or so, when you factor in the transit time required.

But even this is merely a momentary reprieve. We still need a long-term solution.

With Libya Oil Clogged, We Need A Reliable Surplus

As of Friday about 80% of the Libyan supply was off-line. Forces opposed to strongman Col. Moammar Gadhafi had taken control of some pivotal export terminals and port facilities. Yesterday, as we noted earlier, Libyan protesters were permitting crude shipments to resume from certain parts of the country.

Libya is descending into a civil war. That is the next stage in this unraveling – a new dimension guaranteed to prolong the crisis period and provide numerous opportunities for the effect to ignite other countries. Already, we are looking with concern on developments in neighboring Algeria and nearby Oman.

Saudi oil cannot quell the disturbances in the streets. But at least it can calm down global oil trade.

Or can it?

Saudi Oil Minister Ali al-Naimi has said repeatedly over the past two years that Saudi Arabia has an upward capacity in excess of 12 million barrels a day that it can move into the market – and that the country could do so for the next 88 years.

His comment last week – that OPEC would also meet shortages as they appear – is reassuring. But it isn’t particularly significant. Other OPEC members are regularly selling volumes in excess of their monthly quotasThe apparent surplus available there is on paper only.

When it comes to any reliable surplus of crude, Saudi Arabia is it.

And if that country isn’t up to the task, who is?

Two Players Not Up to the Task

It goes without saying that there are possible sources that aren’t part of OPEC.

But each of the main candidates is problematic.

Russia, for example, is now the usual world leader in monthly exports, having displaced the Saudis last year. And the Canadian oil sands provide prospects for additional volume in the longer term.

Yet Russia is facing a rapid maturing of its traditional fields, and significant capital expenditures would be required to keep current volume from declining. There may be some marginal help from the Russians – but not to the extent we may need if an entire region becomes unsettled.

As for Canada, the time element gravitates against a solution. The logistics simply are not there to crank up production rapidly; nor, for that matter, is there a transport network to move the oil where it needs to go. The crisis is erupting much faster than an oil-sands solution can be put in place.

So it seems we are back to relying on Saudi Arabia.

Is Saudi Oil Enough?

First of all, I think it’s clear that I am overlooking the “Armageddon scenario” in the analysis that I’m presenting to you here.

Should the unrest imperil (or even close) transit through the Straits of Hormuz – the primary oil “chokepoint” in the world – the globe would descend into a mega-economic contraction in short order. (On any given day, about 25% of the world’s oil supply passes through the Straits. That includes all of the Saudi supply that cannot be moved by pipeline across the country to Jeddah on the Red Sea.)

But let’s say that does not happen and the increased supply is available from Saudi. Is the Saudi oil supply enough?

Any push that calls for the pumping of more than 12 million barrels a day from Saudi fields is likely to do some serious damage to the reservoirs. And quickly.

Avoiding for the moment the question raised by the late Matt Simmons and others (including myself) as to whether the Aramco resource and field reserve figures are even accurate, the oil market needs assurance that flows are sustainable to avoid rapidly increasing prices.

Personally, what has disturbed me – on each of my visits to Aramco and its fields – is the use of so-called “secondary recovery techniques” at the very start of field activity.

Put simply, Aramco is injecting water into wells almost as soon as they are open. That always means at least two things:

1. Field engineers have immediate pressure problems.
2. And the water flooding will damage the integrity of the deposit and lower overall production.

Putting maximum stress on the production network will only intensify this problem.

And there are two other concerns that are even more pressing.

Higher Refinery Costs, Soaring Demand

First, the Libyan exports are light sweet (low-sulfur) crude. The Saudi (or OPEC, or Russian) crude oil is sour crude (a high-sulfur content oil). High-sulfur crude is more expensive to refine and process into products like gasoline, diesel, heating oil, and jet fuel.

So even if the volume concerns are met, the Saudi solution will still bring about an increase in prices for the end user.

But the second problem – the major one – remains the most basic. Assumptions about Aramco increasing flow to meet production declines elsewhere really means that we have only about 3 million extra barrels a day available. Libya, in full-blow conflict, takes up more than half that amount.

And that excess capacity figure was calculated last year, based on global demand rates. Those rates are now increasing faster than expected.

OPEC itself quietly raised its worldwide demand estimate three times in 2010.

That’s the first time in history that’s ever happened.

By 2012, soaring international requirements for oil may effectively reduce the Saudi surplus to about 2 million barrels a day. That reduces the effective Saudi surplus after Libyan replacement to about 400,000 barrels a day. Period.

Oil traders make pricing determinations based on forward-looking perceptions – not on current availability. If demand continues to rise (and it almost certainly will) and Libyan supply remains interrupted, all we would need is to have a single new hotspot to emerge in the already-troubled Middle East to exhaust the Saudi solution.

As stunning as it may seem to investors, Saudi Arabia might not have enough oil to go around.

From DailyWealth…

Natural gas is back to its record “boiling point” of cheapness.

Source

The last bear market was triggered when the credit bubble created by Greenspan’s foolish monetary policy burst. It was exacerbated by Bernanke’s foolish attempt to debase the currency and reflate the bubble. All he succeeded in doing was to inflate oil to $147, which put the finishing touches on an already crumbling economy.

The market gave us a warning when the financials began to diverge from the rest of the market. Considering that the banks were one of the leading sectors during the `02-`07 bull the fact that they couldn’t follow the rest of the market to new highs after the February `07 correction was a big red flag that the bull was on its last legs.

I’ve been saying for more than a year now that the unintended consequences of QE would be to spike inflation, which in turn would poison the global economy. I knew all along that Ben was never going to create any jobs by printing money and of course he hasn’t.

So if inflation is going to sink the economy and kill the stock market we should see warning signs from the sectors most affected by rising inflationary pressures, just like the banks warned us in `07 that the fundamentals were broken.

Sure enough I think we are starting to see those warning signs.

Emerging markets have been the hit hard by food inflation. We are now seeing food riots in many third world countries. Emerging markets just like financials during the last bull were one of the leading sectors. EEM is now starting to diverge from the rest of the global stock markets. It’s now on the verge of breaking back below the November cycle low.

The other sector that is extremely sensitive to inflation is the transports. When energy costs spike shipping companies profit margins are squeezed. The last two days have seen the Dow Transports fold under the pressure of surging oil prices. Keep in mind oil is only on the 17th day of its intermediate cycle. That cycle lasts on average 50-70 days. I think we are going to see $5.00 gasoline by the time the dollar collapses into its three year cycle low later this spring.

If the market can recover from the recent correction and make new highs I don’t expect the transports will be able to follow. That will set up a Dow Theory non-confirmation and most bear markets begin with a Dow Theory non-confirmation.

China is already in a bear market. I think most emerging markets have probably topped and I doubt the rest of the global markets have more than 2 or 3 months left before the next leg down in the secular bear market begins.

I think the brief party created by Bernanke’s printing press is about to come to an end.

Mr. Market has had an appetite for S&P 500 bears for several months now. In each instance in which the bears think they are going to get away, Mr. Market draws up his high powered rifle and drops the bears just before they can comfortably return to their caves. Just when the bears think they have escaped and are home free, Mr. Market reminds them who is in charge.

However, Mr. Market’s appetite for oil bears has diminished tremendously over the past week as the U.S. Dollar and geopolitical news coming out of Egypt pushed oil prices lower. Mr. Market’s appetite is always changing it would seem, but right now he is enamored with S&P 500 bear meat and not really that interested in the oily bear meat. The question remains whether his tastes will change in the near term, or if he will continue to turn S&P 500 bears into fodder and steak.

S&P 500

With all metaphors and short stories aside, the price action in the S&P 500 for the past several months has been devastating for bears. Going back to November of 2010, every key resistance level ended up being taken out by the bulls and prices pushed higher and they push higher still. Last Friday’s close pushed prices to new recent highs and in time prices may challenge long term overhead resistance levels. The table below shows just how extended the equity market is:

As can be seen above, 82.73% of all stocks are currently trading above their 200 period moving average and over 68% of equities are above the 20 and 50 period moving averages. While this certainly does not mean that prices are going to rollover, it is hard to refute the conclusion that prices in the equity market are overbought.

A quick glance at the SPX daily chart reveals the recent price action.

It is obvious when looking at the SPX daily chart that prices are extended to the upside in this bull market run. However, as I pointed out in a recent article the distance between current price action and the 200 period moving average is significant. There is a total of 167.79 SPX points between Friday’s close at 1329.15 and the 200 period moving average at 1161.36. Based on Friday’s closing price a reversion to the mean (200 period moving average) would produce a decline of around 12.62%. The SPX weekly chart is shown below:

It is worthy of note that the May 2008 swing high of 1,440 coincides with the upper band of the rising channel that is obvious when looking at the weekly chart of SPX. While price action may or may not get to SPX 1,440 during this bullish run higher, it is likely not coincidental that both key trend lines coincide at the same price point. The intersection of the long term rising trend lines corresponding with the upper band of the current rising channel and the 1,440 swing high may be something of import, or it might turn out to be nothing. However, it certainly is an eery coincidence on the chart if you believe in coincidences.

I am still convinced that stocks need to pullback at some point if they are to continue higher. Consolidation or a 5-10% correction would likely be healthy for the market and might prove to be a launchpad for another thrust higher in price. From the underlying strength in the domestic market, a correction or pullback will likely be an opportunity to get long barring price breaking down through the lower level of the rising channel located on the weekly chart.

I am not sure that I am going to get involved in the short side if we see bearish price action in coming weeks, instead I will likely be looking for opportunities to get long equities at more attractive prices. Right now risk to the downside appears to be increasing as the S&P 500 continues to probe higher.

Light Sweet Crude Oil

Oil prices surged when Egyptian protests intensified and have sold off recently as President Mubarak has stepped down and demonstrations have turned into nationwide celebrations. In addition, the U.S. Dollar has strengthened considerably the past few days which has also put price pressure on oil. The daily chart of light sweet crude oil futures is illustrated below:

Oil price are hanging onto a key support level by a thread and price action in the coming week could see prices push lower through the support area and an eventual test of the 200 period moving average. I am not considering a short in oil, but I am looking at lower prices as a solid risk / reward long entry. I am going to be patient, but envision building a longer term trade using options to profit from a possible rally after putting in a clear bottom.

Right now, price could hold above current support levels and bounce higher, but I think the more likely scenario is a brief bounce early this week and then a flush out lower running stops and reaching panic level selling. As is customary for my trading methodology, I will be looking to buy into panic selling should that take place, however at this point I am not interested in getting involved just yet. I intend to remain cautious and will patiently wait for a low risk, high probability trading setup to emerge. Until then, I will be watching the price action from the sidelines letting others do the heavy lifting.

Conclusion

While it may be bear season in the equity markets as Mr. Market continues to punish the ursine, the oil futures market has produced a new home and a new river for eager bears to feed. The question continues to remain how long will Mr. Market punish the short traders in equities while rewarding them in the oil futures pits. Mr. Market may be losing his appetite for bear meat in equities and he might just decide to feast on some bears covered in oil. Time as usual will be the final arbiter, but for right now I’m sitting on the sidelines waiting for Mr. Market to tell me his next order.

Get My Trade Ideas Here: www.optionstradingsignals.com/profitable-options-solutions.php

JW Jones

Outflows in oil won’t have much of long-term influence without the ability to increase marginal supply. A close and retest of $100 as major cycle dates approach would be bullish for oil. Leverage money flows would likely flip from outflows to inflows in anticipation of this outcome.

Crude Oil (WTI) and Crude Oil Diffusion Index (DI):

US diplomat convinced by Saudi expert that reserves of world’s biggest oil exporter have been overstated by nearly 40%

Source:guardian.co.uk

Post Source: WikiLeaks cables: Saudi Arabia cannot pump enough oil to keep a lid on prices

At the risk of stating the obvious, the recent market action in the commodities has been manic with wild gyrations of price in a wide variety of basic materials, metals, and energy. Given these wild fluctuations in price, I thought we could look at an options trade in USO that gives a high probability of success.

In order to give a bit of a conceptual framework for this sort of trade, let me share the way I look at these. Development of precision high altitude bombing during World War II resulted in a dramatic reduction in casualties while inflicting devastating consequences to enemy forces. I view the sort of option strategy described below as the equivalent of high altitude precision bombing. We will extract substantial profit without putting ourselves at high risk of damaging anti-aircraft fire.

As is shown on the daily price chart below, there is substantial support in the region of 35.60-36 provided by a recent swing low and the 200 period moving average.

In selecting the structure of option trades, I usually like to consider the volatility environment in which we currently operate. This is important because a very strong tendency of implied volatility is reversion to its mean. The knowledgeable trader factors this into his trades in order to put the wind at his back as much as possible. Trades can be selected and constructed to benefit (positive vega trades) or suffer (negative vega trades) from increases in implied volatility. As you can see in the chart below, implied volatility is currently in the lower quartile of its historic value for this specific underlying:

Given the current low volatility, let us look at a strategy that gives us substantial profit from an altitude of 50,000 feet and the ability to roll the trade forward for additional substantial profit. This trade is structured as a “ratio calendar spread”. Now don’t go getting hung up on the name, it is simply a two legged trade in which we buy a longer dated in-the-money call and sell a smaller number of out-of-the-money calls. The trade is diagrammed below:

For those getting used to these sorts of trades and trying to form an organizational framework, the trade can be thought of as a basic calendar spread where an additional contract of the long options is purchased. The addition of this extra contract removes the upside limit on our profitability which would exist in an ordinary calendar spread. As is often the case in option trading, this trade can also be thought of as a “first cousin” to a covered call structure where the long in-the-money contracts serve as a surrogate for long stock. I find it helpful to think of the various option constructions as individual members of several different families. Each family has a number of “family traits” that help make sense of the large number of potential constructions available to the options trader.

One of the characteristics of this family under discussion is the “Sham Wow” factor- “but wait-there’s more”. The “more” in this trade is the ability to “roll” the short calls forward as they expire or, more prudently, as they reach inconsequential value. For example, this trade would have been initiated by selling the February 37 calls at a value of around 57¢. When these calls reach minimal value, let us say 10¢ for discussion, they could be bought back, and the March calls sold to capture substantial additional premium. This process can continue for April, May, June, and July. These additional sales give the opportunity to reap additional profit for the trade.

The risks in the trade are:
1.USO breaks support and continues to sell off
2. Volatility collapses on the long leg of the trade

I have discussed both of these factors in the price chart and volatility chart above when I was developing the logic of the trade. While no guarantees exist for the behavior of either price or volatility, the current trade represents a reasonable balance between risk and probability in my opinion.

As with all our discussions, these considerations are presented for educational purposes and do not represent a recommendation. This is not a solicitation nor should it be considered financial advice. I am simply trying to demonstrate how to use the knowledge of option behavior to construct trades that benefit from high probability events. Bombs away!

Get My Trade Ideas Here: http://www.optionstradingsignals.com/profitable-options-solutions.php

J.W. Jones