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Crude oil futures surpass $86
Monday, October 15, 2007
In case you hadn't heard, crude oil futures surged at the end of trading today and closed at $86.35 on the NYMEX (New York Mercantile Exchange) - just when analysts were starting to wonder about the impact of $85 oil, it goes straight to $86.
OPEC announced that "production by non-member countries is likely falling even as global demand for oil is rising". With a near-term production shortfall estimated at almost 2 million barrels a day, demand is now forecast to rise by 100,000 a day over last year during the fourth quarter.
For those of you who own any of the commodity ETFs that hold crude oil futures contracts, you'll be happy to know that "backwardation" is once again working in your favor, rather than "contango" working against you, as has been the case for much of the last year or so.
The condition that perplexed many commodity investors last year, "contango" - when later month futures contracts are more expensive than expiring near-month futures contracts - has reversed in recent months as shown in the table to the right. The oil futures market is now in "backwardation" which benefits holders of commodity ETFs.
Recall that "contango" makes replacing expiring near-month futures contracts with more expensive contracts for further-out months a losing proposition, all else being equal.
Conversely, in "backwardated" markets, fund managers can replace high-priced near-month contracts (e.g., November at $86.35) with a cheaper futures contracts for 2008 (e.g., March at $82.62) and make almost $4 on each contract that is "rolled-over".
This condition persists today because of the short-term production shortfall boosting near-term prices and the expectation that supply/demand factors will return to normal next year sending prices lower.
The ill-founded, yet perpetual "oil prices will be lower in the future" thinking by traders flies in the face of all that is known about peak oil projections and expected demand as a result of emerging economies around the world (see We're going to need a good recession).
The expectation that global demand will remain strong has been bolstered by what many have interpreted as positive reports on the U.S. economy in recent weeks, all of which may contribute to superb performance for commodity ETFs in the months ahead.
10 comments:
should I get a corolla, fit, yaris, or milan?
i can't afford the telsa yet.
ad in the local paper said $8,000 off of a new Hummer, not an H2, but an H3
I find it interesting that OPEC announced, "Production by non-member countries is likely falling . . . ". Isn't Saudi Arabia not keeping up with it's stated intention to raise production, getting all the Peak Oil folks very excited? I don't know if we have reached "Peak Oil" or not, but I think I see something of a deflection of blame on OPEC's part for alleged supply woes.
I say "alleged" because (at least at this point) couldn't most of the increase in oil price be attributed to the falling dollar?
-Vespucian
$86, we hardly knew ya.
$87, we hardly knew ya.
My car was stolen. When I got it back, it had a blown head gasket. It was an old car, a 1991 Jeep Cherokee, so I junked it.
I'm not buying another car; the bus works fine for me.
Maybe I am reading too much into your post, but you use the term "perplexed" with regard to contango.
I have always understood that non-perishable commodities futures are normally in a state of contango - it reflects the carrying cost of the party selling for future delivery added to the market's expectation for future prices; a state of backwardation is the less common situation and reflects a supply crunch for immediate delivery.
So why should a commodities investor be perplexed?
In addition, having to pay contango as you roll over futures contracts should not affect one's ability to profit from increases in the value of the underlying - the baseline is simply reset. I think USO, which has seriously under-performed the continuous contract, is just badly managed and uses contango as an excuse.
It's hard to tell what's normal anymore - as I recall, up until mid-2006 crude oil had been in backwardation for at least a couple years, so, given how things stand today, it is probably more normal than contango over the last three or four years.
Commodity investors were perplexed because of the extreme contango of last year that affected almost all commodity ETFs, many people probably not realizing how the yield roll had benefited these funds in years prior.
Contango and backwardation detract from and enhance, respectively, the gains or losses that you see while maintaining a constant exposure to a commodity by rolling over futures contracts when they are about to expire.
Exactly how contracts are rolled over was a hot topic last year because the U.S. Oil fund had locked themselves into buying only the new front month contract during a four day period at the beginning of every month - they were too predictable and traders took advantage of this.
Deutsche Bank made a big deal about this with their new line of commodity ETFs with what they called "Optimum Yield Roll" or something like that where they can choose contracts for any of the next 18 months to replace expiring contracts.
I'd say that buying a far-out contract at $80 and selling at $87 today is about as close as you can get to a no-lose proposition, but then most people believe the big oil companies and the Saudis when they tell them that cheap oil remain in almost infinite supply.
Tim,
Thanks for your lucid response.
Total oil production peaked 3rd quarter 2005.
Output has remained relatively flat since.
Actual raw crude oil production has declined by over 5%.
Were it not for greater efficiencies in NGL's recovery, total production would have noticably declined already.
Peak oil is here.
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