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Crude Realities: Is $80 Oil on the Horizon?

May 31, 2006

Dear Fellow Options Trader,

Look for more volatility from the commodity markets this week as Venezuela's Hugo Chavez pounds the table for production cuts and increasing OPEC's membership. Recall from last week's newsletter that higher volatility typically generates higher option premiums because of the increased perceived risk.

OPEC controls about 40% of the world's oil supply, and Venezuela has South America's largest gas fields, followed by Bolivia. Tomorrow OPEC meets in Caracas, Venezuela, to determine whether it will continue pumping at near-full capacity.

Neither the request for cuts, nor the desire to enlarge OPEC, is unexpected from Mr. Chavez. His support for the inclusion of Ecuador is the primary catalyst for continuation in the risk premiums associated with many commodities, and here's why.

Bolivia's Evo Morales kicked Western developers in the teeth when he nationalized his country's gas fields in early May. Mr. Morales offered a simple choice to international oil companies: Either return the state land to peasants, or run the risk of the land being seized.

Hmmm. That's an interesting choice -- I'll take column B! This ultimatum, of course, sent shares of mining and oil companies reeling and dramatically increased the risk associated with investments in that area of the world.

Next came Ecuador, which is expelling its largest foreign investor, Occidental Petroleum. Mr. Chavez immediately offered to refine (at subsidized rates) oil exported by Ecuador as a show of friendship and support. Mr. Chavez has been using the billions his oil-rich country brings in to provide similar financial backing to other South American and Latin American countries, and this support has clearly emboldened them, much to the chagrin of multinational mining and energy concerns.

If Mr. Chavez succeeds in getting Ecuador back into OPEC (it was an OPEC member from 1973-'92) and Nigeria backs Sudan as well, we can expect volatility to tack on another $5 or more per barrel for crude, which would bring it close to my $80 target. I sure hope I'm wrong.

TRADE OF THE WEEK UPDATE

HeatSeeker -- my proprietary options activity-tracking technology -- has been relatively quiet, and the volume of options has been extremely light even as the market has vaulted higher. The trap is being set for the early bulls without the volume to support this spike. Without more volume, the rally could really be smoke and mirrors, as many are on the sidelines to get a feel from the minutes of the Federal Open Market Committee meeting.

However, we can clearly see that puts are much more active on the systems than the calls -- a bullish indicator -- although the put activity stands light as well.

That said, I want to wait before I issue a trade for the week -- stay patient for the time being as we look for the right opportunity, and I'll be in touch with a buy alert as soon as I see something that looks good!

Good luck trading and remember -- pigs get fat, but hogs get slaughtered, so don't be a hog!


Jon "Dr. J." Najarian
Editor, ChangeWave Options Trader

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