Middle East Violence Continues Yet Petroleum Retreats from Record Highs

Consensus Report: July 20, 2006

Natual Gas and Oil Report

Middle East Violence Continues Yet Petroleum Retreats from Record Highs as Events are Factored in Yielding Profits, While Natural Gas Ping Pongs from Supply and Weather.

Technical Outlook: In our last report dated July 13 we said natural gas was displaying bottoming action that indicated the short-term correction was over and that a classic bullish divergence exists in the stochastic, linear oscillator, the MACD, and others, suggesting further upside price movement ahead. Only the momentum indicator and a few others showed hints of weakness within the technical framework. We also said that we expected from the current pattern, a near-term challenge to the resistance level at $6.50, that if breached could then quickly be followed by a test of our bull pivot price at $6.65, however the rally came to an abrupt end just below our first resistance level at $6.50 with Friday's peak at $6.45 which was then followed by a sharp and damaging technical freefall all the way back to key support at $5.55. Looking ahead we see technical indicators as mixed however with a bullish bias given today's sudden rebound back above the key $6.0 benchmark to settle at $6.08 and a decisive second consecutive advance following yesterday's powerful rebound from a double bottom support. Despite the recent violent and volatile price swings, the chart pattern is beginning to look more constructive in our opinion as a more confirmed low seems to be in place between $5.50 and the $5.60 support level. Key indicators such as stochastics, the linear oscillator, certain channeling indexes, as well as the longer-term parabolic, all suggest further positive upward price movement ahead whereby our initial target to breach the $6.50 level on close to stage an assault at our bull pivot price at $6.65 is still in progress. Only a sharp retreat from a second rejection at the $6.45 resistance band resulting in a close back below $5.60 would negate our medium-range bullish outlook and return the market to short-term range bound bearish trade.

Fundamental Supply Update

Today the EIA announced an injection into storage of 59 bcfs that was just below both estimates by Dow Jones and Bloomberg of 60 and 62 bcfs respectively. The market quickly shook off the bearish implications of the recent sell-off on supply earlier in the week and then quickly returned attention to the below average supply injection due to last week's abnormally high temperatures in the Midwest and Northeast that temporarily enhanced cooling demand. This defiant countertrend price action over the past two sessions was even more noticeable in the wake of the recent petroleum retreat which we will discuss in more detail soon. Storage now stands at a hefty 2763 bcfs which is still 427 higher than last year and 562 bcfs or 25.5% above the five-year average of 2201 bcfs. Fundamentally natural gas seems to be following its characteristic habit of quickly pricing in the known entity of existing supply, especially if supply is heavy as it is now, and then quickly putting this fact in a backseat position and then short covering prices upward sharply on any sign of threat to future supply such as from a storm or sudden increase in demand such as from abnormal heat. The market seems to be posturing itself for the possible approach of this year's first real threatening Atlantic Basin storm in our opinion. During this period of extreme weather sensitivity we expect the market to be brief on its ventures to visit critical support levels and even more attentive to accommodate the upside on any tropical development from these current low levels. Recent history shows that hurricane season quickly followed by winter, makes for a potential one two punch, whereby past fear based weather rallies catapulted the market to such lofty heights as the $15 benchmark which was exceeded last winter, which makes aggressively shorting this market a very risky venture. Looking ahead we see extended sell-offs below the current established support at the $5.50 area hard to sustain unless weather reports declare an all clear in the tropics over a prolonged period of time. The market will continue also at times to find sympathy with oil price direction especially from extremely oversold levels.

Concerning crude oil the recent violence between the Israeli military upon Hezbollah targets in Lebanon in retaliation for the recent kidnapped soldiers has somewhat faded in its impact over petroleum prices despite Israel's recent advance in the latest development of initiating a more conventional ground war tactic in advancing troops and tanks across the Lebanese border in pursuit of key Hezbollah guerrillas. Prices today posted a modest rebound that was more attributable to expiration related volatility as the spot August contract expired up $.42 to settle at $73.08, while the new September contract finished lower to close at $74.27 a barrel as prices converged closer to the cash market. This followed an almost 6% three-day decline to oil prices as the Israeli conflict faded in its bullish implications as traders grew doubtful the violence would actually interrupt oil flow as the chance of it spreading to Syria and Iran seems remote at least for now. This gave way to a more profit-taking atmosphere that was quickly accommodated by yesterday's EIA report which revealed, although by modest amounts, an across-the-board increase to all of the petroleum complex. The minute increase to crude inventories of 0.2 million barrels was largely inconsequential bringing the total to 335.5 million barrels as supplies remain well above the upper end of averages for this time of year. However, and more importantly the complex leader, motor gasoline increased by a more noticeable 1.5 million barrels last week and now remain in the upper end of the average range. Distillate fuel inventories also rose by 1.2 million barrels and are also above the upper end of the average range for this time of year. But what was probably the most important part of the EIA report and obviously mitigated some of the bearish effect of the gasoline increased was the demand figures which continue to show an elevated level averaging 9.6 million barrels per day or an impressive 1.9% above the same period last year distillate fuel demand also averaging over 4.1 million barrels per day and a very impressive 4.8% elevation above the same period last year in demand. Meanwhile refineries continue to operate at near post Katrina maximum output levels of 92.9% of their operable capacity and gasoline production had increased slightly last week over the previous week averaging over 9.2 million barrels per day, however it's still well shy of the demand rate of 9.6 million barrels per day. Refinery capacity no doubt got a boost from a resumption in production as a key refining hub in Louisiana came back online from an oil spill earlier that had shut down tanker traffic and cut output at one of the country's largest refiners. Also the delivery rate for oil tankers the previous week were not counted due to the Fourth of July holiday. Even with today's new spot valuation for crude oil above $74 a barrel in the new September spot contract is a noticeable decline after the all-time high in excess of $78 per barrel was reached for sessions ago. Gasoline managed to climb for gain of nearly two cents to finished at $2.24 per gallon basis the spot August contract. Some of the recent weakness may also be in reaction to recent testimony in Capitol Hill by Federal Reserve Chairman Ben Bernanke as he indicated the economy may orchestrate a more soft landing rather than robust growth sending a subliminal message to traders that demand for oil may somewhat soften in the third and fourth-quarter as growth subsides. However it is our opinion that it is way too early to draw such conclusions based on expectations for economic growth, the rate of which takes too long to ascertain, leaving the petroleum complex to quickly find more immediate and direct impact factors over price direction such as Nigerian output, restrained Iraqi production, and more timely the Israeli Hezbollah conflict, with of course the most prominent issue and still pending, the potential threat to Iran's production from their nuclear challenge. Now let's take a closer look at the weather as the heat factor has more implications for natural gas whereas the tropics holds serious potential for the entire energy complex.

WSI Weather Outlook 6-10 Day

The other seasonally hot and dry conditions encompassing the western third of the nation this weekend and early next week are expected to come to an end during the 6-10 Day period. In response, highest in the 90s and low 100s will generally remain confined to the southwestern US during the 6-10 Day period. The Intermountain West and interior California will see more seasonable to seasonably warm readings as highs fall back into the 80s and 90s. While the West will generally undergo a cooling trend during the 6-10 Day period, most of the central and eastern US will see the summerlike heat and humidity redevelop as subtropical ridging is expected to rebuild over the eastern two thirds of the country. While temperatures are not expected to be nearly as warm late next week as they have been recently, daytime highs in the 80s and low 90s are Spectre to be the rule for most locations east of the front Range late next week. Portions of the eastern seaboard may see highs as warm as the mid-90s on the warmest days late next week as a cold front turns the wind direct to the West. However, a cold front is expected to bring slightly cooler and drier conditions to the Northeast and Mid-Atlantic states next weekend. For the balance of the 6-10 Day period, anomalies between 2- 6° degrees above normal are expected to encompass most of the continental US.

Conclusion

Natural gas will continues its pattern of falling back to technical concerns once the market has completed a cycle of price factoring to ongoing fundamentals of lackluster, mild weather demand amidst a backdrop of record high supplies. Once again, as we forecast two weeks ago, the market came close to annual low's in the spot August contract that brought values briefly to the $5.50 level whereby value buyers stepped in to stem the decline in simultaneously help the market establish a visual double bottom on the chart that only serve to encourage short covering an increase buying from what is currently and arguably the existing lows of the year! This has reduced prices back to the original formation of the classic V-bottom which we feel this past week materialized. Looking ahead we expect continued support first on pullbacks at $5.92 scaled-back to $5.86 and then of course more critically at $5.60. We still feel the market wants to challenge overhead resistance at $6.50 and then if breached $6.65-$6.80, to confirm the short term a trend. However, should prices fail again at $6.50 or any subsequent lower level, resulting in a breaking close back below key support at $5.60, we feel this would indicate a deeper core weakness leading to a spiked low of $5.25 with the potential washout down to $5.10.

Concerning crude oil and the petroleum complex, the market had earned a much-needed profit-taking after exceeding both of our price targets for oil of $75.80 and then $76.50, with gasoline coming close to challenging the lower end of our upward price bracket that we forecast over a month ago on a Bloomberg News interview concerning a possible run during peak driving season to between $2.40 and $2.50 wholesale price, as this past Monday spot prices hit $2.35 per gallon and a post-Katrina high. While petroleum values have dropped off recently a noticeable amount of between five and 6% just this week we caution traders are getting comfortable with the idea of an extended sell-off as the liquid complex has a habit of retreating after the first approach to a new benchmark which in this case was the lofty $80 benchmark. Crude oil made definitive corrections when first approaching the $70 benchmark as well as the $75 benchmark both of which at times were declines in excess of $7.0 per barrel each time. We feel this was as much a phenomenon of a measured move in relation to technicals as well as at times directly attributable to sudden fundamentals that triggered the sell-off also. Concerning the fundamental aspect on its own merits we continue to reiterate, and feel as we have continued to predict, that unless significant troop reduction is achieved in Iraq which would obviously preclude and suggest a newly established control over the recent escalation to insurgent violence by the new government, or until an unexpected and even temporary agreement is achieved over the Iranian nuclear challenge, crude prices will continue to stay above are critical support level at $68.10 per barrel. And that gasoline will continue to be the complex leader as demand remains robust during peak driving season along with the looming higher storm prevalence that approaches in this year's hurricane season. However, it seems the recent and sudden eruption into a small-scale war between Israel and the Hezbollah as the former continues to pound suburbs outside of Beirut with airstrikes and begins there infantry penetrations across the Lebanese border while the Hezbollah continues to fire rockets into Israeli territories reaching as far as the Christian dominated city of Nazareth, this new Middle Eastern crisis could be the catalyst to propel prices to a whole new higher level. Certainly one must accept the potential that while so many key production areas around the globe are presently experiencing civil unrest in varying degrees yet all of which directly impair or threaten to interrupt current output such is in Nigeria, Iraq, and of course Iran, the sudden arrival of this year's first major Gulf of Mexico storm could easily ignite crude prices to between $80 and $85 per barrel almost overnight. In this very realistic scenario gasoline could also launch to levels not seen since Katrina last year of between $2.75 and $3.0 per gallon wholesale, while natural gas would no doubt make its own headlines jumping a quick $2.0 per million BTU and challenging the $8.0 benchmark! With this nightmare scenario potentially lurking just around the corner, makes for a very uncomfortable environment for the short trader looking to sell recent record highs. Near-term we anticipate crude prices will be Range bound under the current climate of ongoing overseas tension, peak storm season pending, and elevated gasoline consumption over the summer, between a wide range of $69 per barrel and recent contract highs above the $78 per barrel level, until a more definitive development provides the impetus for break out of this range. Unfortunately due to the plethora of overseas tensions that threaten various oil producers, prices are more likely to break out to the upside rather than fall back below our key support at $68.10, which would require a major peace accord achieved in the Middle East either in Iraq or Iran, or longer-term further proof of an economic slowdown here in the United States, or any combination thereof, which at this point all of which seems to be a long-shot at best. While Secretary of State Condoleeza Rice is scheduled to meet with UN Secretary General Kofi Annan on Thursday concerning the Israeli conflict and then fly to the Middle East on Friday to propose a possible cease-fire in Lebanon to lay the groundwork for a possible negotiations to a more permanent and peaceful settlement to the conflict, little success if any is expected from such attempts as the violence continues to escalate as the Lebanese claim over 300 innocent lives have been lost to the attacks whereas the Israelis claim to have lost 29 lives thus far.

FUTURES AND OPTIONS TRADING INVOLVE RISK OF LOSS AND MAY NOT BE SUITABLE FOR EVERYONE.

July 20, 2006

United Strategic Investors Group

Guy Gleichmann, President

1926 Hollywood Blvd Suite 311
Hollywood, Florida 33020

(800) 974 – 8744