Get Ready 'Cause Here They Come

Forecasts for this hurricane season to be one of the busiest ever are showing early signs of accuracy. Tropical storm Alex became our first North Atlantic basin storm yesterday and is rapidly heading for the Yucatan. Several other tropical disturbances are forming off the coast of Africa and Eastern Caribbean. Is it too late to be prepared for potential price spikes on gas and diesel?

Fuel buyers are often hesitant to raise their immediate fuel costs by enacting a futures or derivatives hedging strategy. What needs to be understood is that these minor costs are lowering the risk of major losses should severe supply disruptions occur during the hurricane season.

On Friday RBOB and distillate futures jumped .055 and .075 on short sellers buying back their positions, not willing to risk major losses should Alex become a major hurricane and steering a path North. Back month contracts were also moving higher on hedgers buying futures and options contracts enabling them to add to profit margins should the products continue moving higher.

A solid hedging strategy in preparation of hurricane induced higher gas and diesel prices is to simply by fixed forward contracts and minimizing the price fluctuation risk by buying put option contracts. Of course timing is everything. Fixed forward contracts need to be locked in when prices are falling and put options need to be purchased when premiums are least expensive which occurs when futures are rising.

The difficulty in enacting the above hedging strategy is that it is against human nature to lock in a fixed price when prices appear to want to keep going lower. Using technical analysis to determine monthly support and resistance levels helps overcome the natural resistance to lock in on a down trend, giving the fuel buyer confidence the right decision is being made. Just as difficult is not paying too much for option premiums and waiting for an uptrend to begin before purchasing the put options.

Many fuel buyers and even some producers of refined products, steer away from any hedging strategy thinking it is too costly and administratively difficult to monitor. The extra time, effort, and expense actually gives great price and supply risk protection enabling a distributor to continue operating cost effectively during supply disruptions, when competitors are selling at a loss.

Natural Gas Traders Flirt With "Widow Maker"

Traders who thrive on ferocious price movements crave the high octane volatility of the natural gas futures market. Few other commodities display the whipsaw action that makes nat gas one of the most difficult yet potentially rewarding commodities for speculative traders. Last August it lost 40% before jumping 93% in September. Having an effective hedge to offset potential instant portfolio destruction is essential.

Nat gas spec traders favor fundamental seasonal trends. The problem is that they trade the seasonal trends using logarithmic driven technical analysis. Since many hedge funds are playing the same strategy, money flows in and out like ocean tides. Getting caught out in high tide when the money flows have shifted to low tide has sunk several big name funds.

One of the most dramatic nat gas trading shipwrecks occurred in 2006 when Amaranth Advisors went all in on the seasonal trade of inventory builds from winter to spring known by market participants as "the widow maker trade". Fundamentally demand falls from winter heating season to spring. The problem with this trade is everyone knows about it and is playing it short, if they all head for the exits on any unexpected increase in demand for nat gas, the shorts have to buy their way out of the trade pushing the futures higher and creating more losses for anyone remaining short.

It is always best to enter these futures positions by adding insurance to the trading strategy with, in the case of a short nat gas futures position, nat gas call options. These options can be bought inexpensively at the end of winter, when call premiums are falling. Futures traders often prefer not to eat in to potential trading profits by purchasing options. The peace of mind the hedge brings, however, is well worth the cost.

Crude Futures Giving a Good Rocky Balboa Impression

Having received a knock out punch from its yearly high of $88, crude futures managed to pick itself up off the mat at an intraday low a few weeks ago of $64 and fought its way back to a close on Friday of $74. Congratulations to everyone, Dennis Gartman, in particular, who foresaw the collapsing euro and positioned short on crude accordingly. Will the downward trend continue, or has crude carved out the proverbial bottom?

The energy complex futures are a play on world economic growth. Crude made its precipitous fall when hedge funds began worrying that debt problems in Europe would derail world growth and subsequently world demand for energy. Hedge funds began moving as a herd in early May, selling out of long ETFs and futures positions and either going short or playing it safe with their capital by sitting on the sidelines.

With strong economic data coming out of China this week, capital flowed back into energy, as traders saw value in cheaply priced crude, distillate and gas futures. Even the euro began responding last week to positive to successful European bond sales. US equities also showed positive signs that it too has created a technical bottoming formation. These are all evidence that the crisis is over and demand will begin eating away at record energy supply levels.

Traders are likely to be cautious this week and prefer waiting for crude futures to dip back to the lower end of the near term $69 to $75 trading range before adding to long positions. However, volume will increase on the lower end helping to ensure that a bottom is in place and allowing more aggressive traders to load up on any pull backs this week.

China's Strategic Energy Plan

Petrochina, Sinopec and CNOOC are China's three mega state owned mega petroleum companies. These companies have been on a buying spree since February 2009, crude's low end of a multi year trading range. Flush with cash and understanding that China, in ten years will have depleted its own crude resources, these state supported entities have been on a crude supply buying tear, locking in as much petroleum resources as possible, by offering loans and drilling technology with the help of the Chinese government.

China well understands that although new energy substitutes are being developed, these new fuel technologies will likely not be available for twenty or thirty years. Locking in long term supply at current prices places China in a highly favorable strategic advantage.

Currently the United States is dependent upon China to buy our bonds to fund our ever growing debt. In the not too distant future we are likely to become dependent upon China to supply us with fuel to keep our country operational.

Crude near month futures closed today near $71. With depleting supply and increasing demand it is not unreasonable to expect crude 2012 futures to be trading in the $200 to $300 range. At those prices China has gained a major strategic advantage over the United States and places us at a major security risk.

The Obama administration needs to be thinking immediately of how we can incorporate our most abundant fuel resource, natural gas, into our mainstream fuel supply. Failure to take action now places our future into the hands of the Chinese government.