Crude oil prices have plunged far below what the oil fundamentals might suggest and even hardened bears are starting to question this selling madness. The price drops and current levels will destroy the myth that U.S. oil production will rise regardless of the price and we are already seeing downgrades of those energy stocks across the sector. Downgrades are coming fast and furiously. Barron’s reported that Seaport Global Securities downgraded 51 energy-related stocks in the exploration and production arena, as well as offshore space. Morgan Stanley also reportedly lowered its outlook for the oil services industry to “in-line", citing increasing odds of a bearish outlook that sees a 30%-50% downside to historical valuation support. Macquarie Energy downgraded Chesapeake, BP, Chevron, Royal Dutch Shell saying that global oil majors will slip back into deficits and suffer additional painful cost reductions.

I think you get the picture. This sell off will have choking ramifications on future oil production at a time when we are seeing oil inventories start to fall. While global data is hard to decipher, we do know that the U.S. does see another drop in U.S. crude supply adding to the biggest trend in falling supplies in our history. Sure, we are coming off extremely high levels of supply to begin with but the trend of falling supply in the U.S. is not an argument. Crude inventories fell by 2.5 million barrels more than the 2.1 million barrels decrease that was expected. Even gasoline stocks fell by 578,000 barrels at a time when they normally rise and at a time when refiners are cranking out near record amounts of the stuff.

What is an argument is what does this mean for our future. Talk of oil floating in storage is making the rounds again and talk that shale output will reach 10 million barrels a day will be put to the test. Unhedged shale producers better hope that their line of cash does not dry up and hope the money men have the vision to see through this epic price collapse. Yet with the rash of downgrades, the sense may just be that they would be throwing good morning after bad. Shale producers will stop adding rigs and production, that while we saw at new highs yesterday, should start to moderate and fall back. Prices need to bounce back quickly or we'll see another round of energy job cuts as well as Cap X cuts across the sector. Price collapses like we have seen too often will make it harder and harder for many oil companies to raise capital.

In the meantime, Tropical Storm Cindy is shutting down gulf oil production. The Bureau of Safety and Environmental Enforcement (BSEE) says that as of yesterday, based on data from offshore operator reports submitted as of 11:30 CDT, personnel have been evacuated from a total of 40 production platforms, 5.43% percent of the 737 manned platforms in the Gulf of Mexico. Production platforms are the structures located offshore from which oil and natural gas are produced. Unlike drilling rigs, which typically move from location to location, production facilities remain in the same location throughout a project’s duration. Personnel has been evacuated from one rig (non-dynamically positioned (DP) rig), equivalent to 6.67% percent of the 15 rigs of this type currently operating in the Gulf. Rigs can include several types of offshore drilling facilities including jack-up rigs, platform rigs, all submersibles and moored semisubmersibles. There will be another update later today.

Sharp sell-offs have ramifications. The last time we sold off like this in early May we snapped back. Even as the mood is negative, we expect a similar snap back. While U.S. output did rise by 20,000 barrels a day last week to 9.35 million barrels a day, the increase for the month is still below what was expected. We really think that this selloff is being driven by emotion rather than fact and we should see a snap back. Great time to buy some cheap calls.

Natural gas has been pressured by cool weather forecasts but production shutdowns in the Gulf of Mexico is going to raise real concerns about meeting demand and building storage when temperatures go back to normal. You want to buy calls when the market looks this bad. As the old saying goes, the market always looks worst at its bottom.