Schork Oil Outlook: Producers About to Head-Fake Bulls?

“The rig count rose further over the reporting period and most of the increase was in oil-directed drilling. Even with the drop in oil prices from $85 to $70 per barrel, oil-directed projects remain profitable. In contrast, at $4 per MMBtu prices do not justify unhedged shale gas drilling. Hence, as current hedges expire, contacts say that there will likely be a slowdown in gas-directed drilling.”

– U.S. Federal Reserve Bank, Dallas District
Beige Book, June 9, 2010

In between the Fed’s March and April Beige Books, short positions in the Nymex’s Henry Hub futures contracts held by producers dropped from over 25,000 to below 500.

As these hedges expired, i.e., as production likely increased, spot Nymex gas moved from a peak of 4.869 (March 1) to a trough of 3.810 (April 1). As such, we are now coming out of one of the strongest starts to the refill season on record.

Since the April Beige Book, through yesterday's Fed report, spot Henry Hub futures rallied to a peak of 4.995 (June 8). Producers apparently took advantage of the rally as they increased their short position from below 500 contracts to over 14,000 as of a week ago Tuesday.

In other words, the Fed’s anecdotes notwithstanding, producers could be getting ready to dump molecules onto the market.

If that is indeed the case, then as further explained in The Schork Report, the sooner the bulls break resistance at the 62% retracement on the Nymex, 5.100, the better off they will be.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.