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UPDATED: The Oil Market's Historic Swing to Continuous Contango--Has Peak Oil "Tipped"?
Posted by jeffvail on May 20, 2008 - 6:30pm
Topic: Economics/Finance
Tags: backwardation, contango, oil futures, peak oil, peak oil meme [list all tags]
To the greatest extent in the history of oil futures trading, oil prices are now in continuous contango--that is, oil futures get progressively more expensive each year into the future. Does this mean that Peak Oil, as a meme, has "tipped"? Our latest oil price poll suggests that well over 70% of the sample (N>3000 now) thinks that oil will at least stay above $114 a barrel for the next two months--and almost half think it will hit $140 a barrel in that timeframe. Search volume on Google for the term is up dramatically in the past month, as is traffic at The Oil Drum. The following graph shows the dramatic swing from backwardation to contango over the last 6 weeks:
A few quick definitions: Backwardation is when prices in the future are lower than in the present. Contango is the reverse, where future prices are higher than in the present.
Backwardation is the historical norm in oil futures markets, and it is conventional wisdom that there are fundamental reasons for this "normal backwardation." While contango has occurred in the past in oil futures markets (most recently in 2005 - 2006), past occurrences have always been "partial" contango--where prices increase for some years, but decrease beyond that. This type of contango is explained by expectations of near-term shortages, and can be seen in this chart of the backwardation curve in crude oil from February, 2006:
The rapid swing to contango between May 16, 2008 and May 20, 2008 is unprecedented for both the degree of continuous contango and the rate of price movement (today's $9+ advance in December 2016 futures is the largest single advance in history). What was the cause of this shift? Has market awareness and acceptance of Peak Oil "tipped"? This morning both Boone Pickens and Robert Hirsch appeared on CNBC discussing oil markets, with Hirsch laying out an explicit and forceful case for Peak Oil. While the appearance of this historic contango in the oil markets is not dispositive of a sudden market awareness of Peak Oil, I think it is the most likely explanation. Either way, the situation certainly bears scrutiny and discussion...
Thanks again Jeff - as before - the 2016 futures is leading the pack (not shown in graph). Was up $9.50 to $139.50 while front month was only up $2.00 to $129 - so there is $10+ of contango on the long end...
Sorry for continuing to exclude the 2016 data. I've been compiling the price sets by hand (as I haven't found a good source of free historical data for all contract months) and for some reason neglected the 2016 data points until May 16th...
Jeff,
Can't thank you enough for the info earlier, bought two groups of futures
that right now look so, so very good.
Blair in Oregon
I think part of the shift relates to risk management ON THE PART OF PRICE MAKERS - what is the incentive to short (or sell) oil years hence -i.e. 2016 (to buyers-customers) at a discount to the spot price/front month in a tight market. The price maker has to sit on 7 years of "disruptions" and needs the price to fall just to be in court. As oil prices rise, nominal swings become bigger, and therefore a premium for long dated prices would be natural. Have been expecting this shift to kick in, above 100, for best part of 5 years. Think the curve should add 10 bucks per year (i.e. 150 front/220-250 back end). Issue of storage is lack of availability of storage facilities and oil tankers for movement of cargo.
But believe the real driver right now is pre-positioning for news flow coming JUNE
However, it will have a major impact on policy-makers and sentiment if sustained: market expects higher prices and therefore more inflation, dollar devaluation. Hoarding could be spurred by "cheap" front end versus expensive back end - could significantly boost short term demand and the front contracts.
"But believe the real driver right now is pre-positioning for news flow coming JUNE"
I guess I missed it. What news is coming in JUNE?
Thanks
My 2¢ worth:
In my opinion, we are looking at an accelerating net oil export decline rate, combined with a requirement for an accelerating rate of increase in oil prices, in order to balance supply & demand, as forced energy conservation moves up the food chain.
Let's take all consumers in all oil importing countries and break them into five groups, and then rank them by income. So, at the bottom of the bottom quintile, we have a poor Third World consumer. At the top of the top quintile, we have Bill Gates. As we go up the income ladder, the cumulative purchasing power vastly increases, which as noted, IMO, suggests a requirement for an accelerating rate of increase in oil prices in order to balance supply & demand.
I think that these two factors will interact--and are interacting--to produce the following oil price trend: $50, $100, $200, $400, $800 . . .
The question is the time period between the doublings.
well just remember that we have a rebound effect in place: the OECD is paying 125 bucks, but the Non-OECD and specifically the petro-exporters are not. So higher WTI-Brent feeds into fast growing petro-exporting nations, that then have less oil for export to the OECD, which in turns boosts WTI-Brent even more. Oil for export is the key. And the non-OECD Petro-exporters tend to have the fastest growing populations, fastest growing economies, and subsidized energy prices. Looks like a wicked circle at the moment
The opportunity cost for both groups is the same, though. Not selling the oil means not getting the $125 means not getting whatever else you could get for that $125.
--
JimFive
Not Quite.
Yes - both groups have the same opportunity cost - however, the petro-exporter simply seeks a higher price for that which remains for export, to compensate for the lost opportunity of selling output at subsidized domestic price. And as the domestic market is always fulfilled first, the projects initiated years ago, to meet projected global demand today, at originally projected lower prices, get mopped up by the higher domestic demand spurred by the (perceived) unexpected intl price rally.
Remember- non oecd petro exporters are typified by state planned economies - therefore higher revenues feed into commodity intensive domestic activities - new oil and gas projects, new infrastructure-national projects, militarization (to recycle petro dollars/geo-political insecurity). Meantime in the OECD rising energy prics feed into energy intensive or consuming activity: spr, military deployments, new alternative energy projects and infrastructure, non conventional oil.
So both groups (oecd/non-oecd) become more commodity and therefore energy intensive in behavior as the supply-demand balance converges, and a public sector crowding out effect is evident, as are rebound effects (higher oil price than expected>higher commodity demand the projected>higher energy demand than expected>higher oil price than forecast)
As such, it is had to see what will kill the loop except and outrite spike triggered by a physical supply cut
I did not mean my comment to sound like I was opposing the Export Land Model. I think what is indicated is that the price of oil is not accurately reflecting the value of oil, in the following sense: Oil is more valuable to the producer than the money the customer can offer, up to the point where the producer has an excess. Once the producer has filled his own needs then the market price gets set based on what the consumers are able to afford. Since there is no readily available substitute for oil the first X million barrels a day are, in effect, priceless to the producer.
--
JimFive
I disagree. The question is how wide the disparity between rich and poor can get before social conditions deteriorate. If one drives a car an average of 12,000 miles per year - at 20 mpg. Thats about 600 gallons of gas - at $4 that is about $2,500 - not going to impact the rich one bit. But people with car loans, house loans, vacations, etc. that might be good slug of their discretionary income - if it doubles again there will have to be new social rules. People won't just stay at home and they won't be able to commute to work at the margin. (new social rules =carpooling, curfews, odd even driving days, and the other IEA recommended measures at a minium, but may require rationing, consumption taxes, and further measures.
"..further measures", Nate? Like civil disorder and revolution, maybe......?
The difference between $60 oil and $120 oil is that forced energy conservation is simply moving up the food chain--from a poor third world consumer to lower income and middle income Americans.
Let's assume, for the sake of argument, an annual net export decline rate that looks this: -2%, -4%, -6%, -8%, -10%. . .
We get a price response, followed by a demand response, and then we get a sharper decline rate, requiring an additional price/demand response--aggravated by the fact that forced energy conservation is moving up the food chain. Wherever we are headed and whatever the consequences, IMO, this is what is driving the price. A steady exponential decline rate would show up on the following chart as a flat line. What we see is an accelerating net export decline rate:
Increased oil prices reduce almost everyone’s disposal income (it acts as a tax).
For the US a doubling in the oil price will heavily impact their already high trade deficit? How long will other nations be able or willing to finance an accelerating American trade deficit?
Some of this lenders like China will also be impacted by the increase in oil prices, and should thus (under equal circumstances) be left with less US dollars to finance an accelerating US trade deficit.
Obviously something will have to give when the oil price reach critical levels (I don’t know what that price is as of now and when in time this will happen) even adjusted for a US dollar in almost free fall.
The increase in oil prices will affect food prices, interest rates, travelling etc. thus forcing the average household to increasingly prioritize their available means.
NGM2
It does not act as a tax. A tax moves money from the citizen to the government which the government then (ostensibly) uses within the domestic economy. A high oil price (for an importer) moves money from within the domestic economy to an external economy. Since our economy is measured by how much money is moving around within it, moving money outside of the economy is bad for the economy.
--
JimFive
Jim,
Thx for the more precise formulation. (slight populistic use of a picture from my side)
For an oil importer I agree, increasing oil prices will move and increased amount of money out of the economy.
My prime intention was however to draw attention to that there must (as of now) be a limit to how high oil prices will go before it starts to affect demand.
Looking at EIA data for total petroleum products consumption it looks as this zone is being entered now, looking and the increasing number of airlines reporting cutbacks and reduction in flights, the present run up in oil prices have already stated to take some effect on demand (consumption). And there is probably more in the pipeline.
I would expect there to be a timelag from the run up in prices until it turns up in reduced demand.
NGM2
Why no put some meat on this prediction?
What is the year (or range) in which you expect oil to average $400?
After all, to learn that oil may average $800 in the year 2150 when we have long since moved on and it is used only for specialized niches isn't really a big deal.
Here’s my prediction from more than two years ago. The original unedited version said that “These factors will interact this year to produce an unprecedented—and probably permanent—net oil export crisis."
http://www.theoildrum.com/story/2006/1/27/14471/5832
Hubbert Linearization Analysis of the Top Three Net Oil Exporters
Posted by Prof. Goose on January 27, 2006 - 1:47pm Topic:
[ED: This is a guest post by westexas...]
Well, that doesn't do us much good. We need to know the price. You bandy prices around on a regular basis. Why not stick a year on them?
Well, this is this more recent quantitative assessment, that provides some hard numbers for future net oil exports, with a qualitative prediction for prices:
http://graphoilogy.blogspot.com/2008/01/quantitative-assessment-of-futur...
MONDAY, JANUARY 07, 2008
A Quantitative Assessment of Future Net Oil Exports by the Top Five Net Oil Exporters
by Jeffrey J. Brown and "Khebab"
But I find Saif Lalani 's price projections to be pretty reasonable, based on similar assumptions about net oil exports:
http://www.financialsense.com/fsu/editorials/lalani/2007/1028.html
POST-PEAK PRICES $1,000 a Barrel Oil / $20,000 a Pound Uranium
by Saif Lalani
October 28, 2007
So....$1000 within 10-15 years?
How about a range of years for $500?
Sure, it will hit $500 within a range of years.
See, that's what sometimes happens when one starts to poke at all the hand-waving going on. Eventually there is just nothing concrete. The pundit suddenly gets cagey and starts looking for a place to hide.
Yeah, I guess I wasn't specific enough about my warnings about Saudi and Russian oil production. Perhaps I was too subtle.
And perhaps I wasn't sufficiently clear about where I thought net oil exports were headed.
Or perhaps I wasn't sufficiently clear about my repeated ELP warnings to downsize ASAP, in advance of predicted rapid increases in food & energy prices.
Maybe people thought that I was too vague about my opinions about the future of suburban real estate.
My continuing apologies for my shortcomings.
I'm sure that your work has been much more precise. BTW, what work have you provided to the debate?
My current job here is to nail down a rough time line on the continuous doubling of prices that is part of your Export Land Model.
Then I might be able to advance the debate....
We can say that at their current rate of increase oil prices would double about every year, but you didn't answer my question. Is the answer none?
Unless he's been lurking for some time, I think Mr Asebius may be a pushy journalist looking for some sort of sensationalist prediction that will make a good headline. I hope he/she is. The more the MSM learns and helps spread the mesasge the better.
Nah. George has had many previous lives.
What George is is inflexible in his thinking and into picking fights. Here we have excellent and precient work from WT and Khebab giving us scenarios based on crunching numbers and constantly refining them to give people a heads up about wtf is coming down the pike.
Now, George can't be bothered to notice that what he's asking for is not what is being offered. Because he has an agenda. He wants predictions where none are offered or even possible. On top of that, WT does not seem very interested in exactly what price is seen when, but seems quite interested in when flows start reducing. Price will do what it does based on the flows.
Since George is not interested in learning more and apparently has nothing to offer to contravene WT and Khebab's work, he merely seeks his "Gotcha!" moment so he can't point back and say, You were wrong! Nothing you say can be trusted... even as exports fall through the desert floor.
At least, that's my take on George.
Cheers
Agreed. In short, George is a jackass.
In my peak oil related media appearances lately, all the journalists seem to want a specific price target and a date. I guess that's what makes news, in their book. But, like Hirsch & Simmons & others who have been put the question, I answer that there is no way to predict it, because the effects & timing of demand destruction cannot be predicted with any rigor.
IMO being asked to predict oil prices & dates is simply a "gotcha" trap, as you said. The important thing is to understand the trends. But that doesn't sit well with sound-bite media, or message board trolls...
If you go through the Hirsh 2007 update on peak projections for the DOE, and look to see which of the notable people making predictions about production, are also prepared to make predictions about price, you find they are few and far between. The reason is that production is science, market economics are sort-of-science, with a big dollop of the human condition thrown in.
It's totally unreasonable to knock someone contributing significantly to our understanding of oil supply for being somewhat vague about prices - in fact, if WT started giving price predictions, I'd be forced to somewhat discount his other work as likely to be unreliable.
Two examples I found of people talking about both peak barrels and dollars per barrel. CERA (always wrong) T. Boone Pickens (closer to right, but still wrong)
Missing the forest for the trees.
Because someone can't tell you what you will eat and when you will eat to an arbitrary precision, this means that in the future you will never experience hunger pains?
Perhaps we can pay more attention to the system, to the forest.
Hello Jeffvail,
I hope contango will increase the Peakoil Shoutout* fandango in pubs.
* When your favorite yeasty beverage glass reaches half-empty--you shoutout Peakoil in recognition of finite limitations and maximum attainable flowrates.
I am constantly trying to make this a new cultural tradition. Please encourage others to participate. I can think of no better way to posthumously honor Marion King Hubbert.
Bob Shaw in Phx,Az Are Humans Smarter than Yeast?
I think a fine tradition has just been born. Thanks Bob :)
" * When your favorite yeasty beverage glass reaches half-empty--you shoutout Peakoil in recognition of finite limitations and maximum attainable flowrates. "
Bad idea. Anyone who does this in MY presence will need to drink the rest of their beer through one of those coffee-stirrers (the ones that look like a collapsed straw).
Just for you.
http://www.prometheus6.org/images/toughguy1.jpg
zen zen wakaranai.
?
I think that it's also worth pointing out that, while this has been a dramatic swing that must be apparent to traders, it has received virtually no coverage in the US press. The UK Telegraph and the Financial Times covered the story peripherally, but there has been no mention that I'm aware of on any of the network or cable news programs (including CNBC, which must require actively working to avoid the topic seeing as they talked about oil for hours today! A search of their website shows no use of the term "contango" during 2008)...
Is this ignorance on the part of the financial pundits, is it a belief that their audience isn't capable of understanding the discussion, a desire to not address the topic, or do they genuinely believe it isn't newsworthy (despite the fact that the UK press seems to feel otherwise)?
Jeff,
I've seen nothing on contango in the news slots on CNBC - I use the term "news" loosely - but there was a Fast Money segment where one of the traders cited contango as proof prices were not going down. It was quite a long rant. I believe I got the original link to that video here on the Oil Drum . . .
Cheers,
fat_tail_rider
actually on CNBC's Fast Money tonight, Joe Terranova talked quite a bit about it...lots of talk of the back end of the contracts, etc. He's the one in that video from last week.