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Contango is not necesarily considered the "normal" state of affairs for all commodities. Grains are harvested once per year, and in a normal year that supply must be allocated over the coming year. Higher prices for the contracts late in the crop year are the market's way of encouraging storage. In a short crop year, price are higher in spot markets and nearby months to discourage storage.
Crude oil, however, is produced continuously. It is not at all unusual for the crude oil futures market to be in either contango or backwardation. Both conditions have prevailed for extended periods over the last two decades. The point still stands, however, that a backwardation reflects a tight current balance between supply and demand that is expected to ease going forward, and a contango would relfect the opposite situation.
The thing that is most interesting is that the distant contract prices can be interpreted as the market's long run forecast regarding the supply and demand balance. As such, distant contract prices are much less volatile than spot prices and the prices of nearby contracts, which reflect every short-run production/distribution interruption, the current year's weather, etc. The market anticipates such short-run issues working themselves out in some limited amount of time. Distant contracts' prices, by contrast, reflect more signal and less noise.
The prices for delivery of crude oil five years in the future were very stable at around $20 per barrel for most of the history of the NYMEX contract prior to 2003 (I wish I knew how to post a spreadsheet chart that I created that shows this). Since that time, the five-year forward price has gone up fairly steadily to its current level of around $65 per barrel. The market concensus regarding the long-run balance betweeen supply and demand is changing substantially. There is the big story.
I agree - it's the rise in distant future price that's a real sea change. No more "oil will be back down to $20/barrel" any more.
The prices are for NYMEX crude oil futures contracts delivering about 3 years in the future in the early 1990's, as the futures did not trade 5 years out back then.
subtr4ct
If the end is chopped off, here's the link to view it directly:
http://i78.photobucket.com/albums/j100/subtr4ct/oil.jpg
It really spikes up, starting around the beginning of 2005.
It would be great to compare it to then-current oil prices to see how it compares, but I need to know what the dates mean.
The first observation is the settlement price on 11/23/1990 of December 1993 futures. The last point is yesterday's closing price of Dec. 2011 futures.
This graph is one of the most compelling illustration of the "Peak Now" that I have seen this year.
This really helps to debunk the view that the current 'plateau' is just another little hiccup in the march on up to 120Mbd in 2030.
Thanks a lot for posting this graph. I hope Stuart can add this to his "why we're probably peaking now" page.
Note that I have used a dollars per 100,000 BTU price (not the conventional dollars per 1,000,000 BTU price) to make the two series of comparable magnitude.
But governments could intervene and your options may as well be worthless. But peak oil in combination with inflationary fighting measures could so devastate the economy (via deflation) that oil five years could cost only half as much as it does today. But one shouldnt rejoice if average income has fallen to one tenth of today's level.
Has anyone else thought about this? Peak Oil decimating the economy to the point where the price of oil falls simply because of deflationary pressures (think cascading unemployment reducing demand for virtually everything which in turn reducing pressure on scarce resources). Add in potentially restrictive government restrictions like gold confiscation or protectionist terrifs or high interest rates or permitting employers to unilaterally cut salaries).
Or is the inflationary route pretty much guarenteed?
What government intervention has been or could be used?
To me, if (or once) the market accepts Peak Oil, then the degree of contango--especially in the 3-5 year out range--will represent the best market information on interaction of declining production and demand destruction. This will, I'll argue, not actually be "contango" per se, as it will not be caused by the same market forces that cause "standard" contango--it might look more like contango in S&P500 futures back in 1995. That is to say, it will move upward sharply based on future assumptions of declining production. If global decline proceeds at 5% beginning now, how much could we expect to see the futures price increase year-on-year? 10%? I have no idea how to begin calculating this. It does strike me, though, that contango is constrained at some point by arbitrage: if contango is at 10% a year moving forwards, that will exert a strong pressure on current spot prices because of increasing demand from arbitrageurs who sell a future, buy and store the oil, and deliver. Depending on how well inflation risk can be hedged with other instruments, and the performance expectations of other markets, I suspect that contango exceed 15% a year because of arbitrage pressure... any historical data or thoughts to back up this concept of contango and arbitrage dragging spot prices up by the bootstraps?
It's harder to say exactly how big the increase could become before this is a major factor. And of course we might see short term fluctuations that are substantially larger. In principle any rate of increase above the prevailing interest rate could trigger the effect (this is the Hotelling model for production of exhaustible resources). That would be 5-6% per year. In practice it could probably be a little more than that but I guess I'd be surprised if it stayed above 10% per year.
Note that this effect looks to the naive eye like greedy speculators are artificially driving prices higher than they should be under conditions of supply and demand. And note too that we have heard exactly this charge in recent months, as oil prices have stayed high despite a short-term glut as evidenced in growing storage inventories. However Hotelling showed that this production profile is actually optimal in terms of maximizing the net economic value of the oil.
We should be glad when this happens; by slowing down current oil consumption we leave more for the future. Some people argue that this is not enough, we should tax it to make it even more expensive, but this is economically inefficient and will cause excess and premature consumption declines. It makes people poorer today and gives them fewer resources with which to deal with future challenges. The best method is to let the market predict future prices, let those future prices drag up today's prices, and trigger conservation on that basis.
The effect should work in the other direction, too, BTW; if future oil prices are not rising at a decent pace (i.e. keeping pace with inflation plus a few percent) then we would expect to see higher production today, leaving less for the future. This effect may have been operating in the past but we will likely see a transition away from it as we approach the peak.