<Friday open threadThe Oil DrumWhat would we have predicted for Kuwait?>

67 comments on Oil Prices

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Agric on January 20, 2006 - 9:51pm Permalink | Subthread | Parent | Comments top
Future oil contract prices are still a function of current price plus basic financial factors plus a bit of sentiment (in which I would count peak oil).

If futures markets thought peak oil had a 50% chance of happening by 2009 then the price for Dec 2010 oil would be well over $100, since the price of oil after peak will probably be $200 and accelerating. The markets have not even begun to price in peak oil.

Today's (and recent) increases in price are despite a reasonable supply picture and high stocks (within the US anyway). The increase is partly due to an oversold state of the oil market in early December, seasonal factors, a bit of supply constraint in Russia and Nigeria, and a general jittery feeling. Any significant supply disruption (of maybe 2mbpd) or geopolitical event in the next few days could bring $100 oil in a blink. Barring that we could see the price get close to $70 but it will then retrace to near $66 and await the next mood or event.

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wisco on January 21, 2006 - 9:26am Permalink | Subthread | Parent | Comments top
If you are purchasing a contract for 2012 oil delivery, you are wise to discount your price based on some likelihood that the contract will not be honored. We are just starting to see how tenuous our trust is with major producers can be (see Iran vs. Turkey, Russia vs. the World, Venezuela vs. US).

Send me your $60 today, and call me in 2012. I'll have your barrel in the garage!

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Johnny on January 21, 2006 - 11:22am Permalink | Subthread | Parent | Comments top
How about if I send you $60,000.  Will you store 1000 barrels for me?
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wisco on January 21, 2006 - 5:13pm Permalink | Subthread | Parent | Comments top
SURE! 1,000 barrels, 10,000 barrels, whatever you need, just send me the check today and then give me call in 2012. I'll promise I will deliver the oil right to your door within 30 minutes of your call!
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Agric on January 21, 2006 - 12:19pm Permalink | Subthread | Parent | Comments top
Likewise your pension fund, insurance policies, any derivative of money, maybe even money itself.

I really enjoyed this article on Alan Greenspan, told from his point of view, even laughed out loud a couple of times:
http://www.financialsense.com/editorials/daily/2006/0120.html


Others say that my real legacy is that I finally "made central banking work." Yes, I made it work...just like it's supposed to work, giving the people enough rope so they could hang themselves. That's what they've done. Now, they dangle from a long rope of mortgages, deficits and credit cards.

And I am delighted. Soon, people will be able to see how central banking really works. And poor Ben Bernanke will get the blame for it. He and his stupid helicopters...he almost deserves it.

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Nate Hagens on January 21, 2006 - 1:31pm Permalink | Subthread | Parent | Comments top
Several thoughts:

1)If you buy a futures contract expiring in 2012, you dont have to hold it until that date to take profits/losses/delievery - you can get out anyday and your equity is marked to market everyday. The force majeure event that you imply would likely not happen overnight, though I guess 'one' overnight it will.

2) The futures strip for oil out to 2012 has its highest price in January 2007 at $70.16 gradually declining to $63.10 in 2012. source nymex.com This implies that either a) the 'market' believes that new production after 2007 will offset depletion b) demand will be lower after 2007 c) long dated futures are so illiquid as to not be true voting mechanisms for large dollars (if someone could buy 1 billion$ worth of 2012 futures they would, but even buying $500,000 worth is hard to do) d)the market (and society) predominantly only looks 1 quarter to one year ahead in pricing e) that from 2008 to 2012 our liquid energy will be provided increasingly by ethanol, biodiesel, coal-to-liquids, tar sands etc.  

It could be a combination of all of the above but I beleive most likely a combination of a) and e). What the market is missing is that these new energy sources are borrowing from Peter to pay Paul (tar sands require nat gas, biodiesel takes away some food production etc). Thoughts welcomed.

3) We keep hearing about how US natural gas futures have plummeted. Indeed they are down 50% from their highs of a few months ago due to VERY mild weather (55 in vermont today). But if one uses the NYMEX strip and takes the AVERAGE of all monthly futures prices over the next 6 years (not just the front months this winter), one discovers that natural gas has actually increased 11% in the last 2 months (even while the financial news media has pointed out that NG plummeted from $15.75 to $8.90). Long dated structural problem is being recognized - 2010 futures strip is up 25.5% from its November 2005 levels (when NG front month was over $15). In other words, averaging the entire futures strip of natural gas futures shows that this aggregate closed at an all time high yesterday.  Interested in Freddy and others thoughts here...

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Halfin on January 21, 2006 - 8:11pm Permalink | Subthread | Parent | Comments top
Sasquatch, what you say makes a lot of sense. Speculators don't have to worry too much about failure to deliver. Hedgers who are hoping to actually take delivery may have more worries, but they can still use margin to gain protection against adverse price moves.

As far as the structure of the future price curve (one that is seldom charted in print for some reason), I agree with you that the bottom line is that the market views today's problems as more or less temporary. I think most traders still believe that oil and alternatives will be able to grow to generally meet demand over the next five years (perhaps keeping in mind that demand growth may be suppressed at today's high price levels).

One thing I have noticed is that when the market moves up, long term futures move with them but to a lesser degree; and likewise with downward movements. Long term futures tend to lag behind short term ones, which is basically what you would expect. The result is that after a strong upward move (like now), long term futures are lower than in the present (backwardization); while after a short term decline, long term futures will be higher (contango).

That's also very interesting news about natural gas. I looked at the Dec 07 future price here:

http://futures.tradingcharts.com/chart/NG/C7

You can plainly see the steady upward trend over most of the past 6 months, in great contrast to the seesawing of the short term futures price. Interestingly you don't see the same effect with long term crude oil, that has been up and down almost as much as the spot price. So if the NG market is recognizing structural problems, that doesn't seem to be happening yet with crude.

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mcain6925 on January 21, 2006 - 9:33pm Permalink | Subthread | Parent | Comments top
If you are purchasing a contract for 2012 oil delivery, you are wise to discount your price based on some likelihood that the contract will not be honored.

You should also be discounting your price by the time-value of the money and goods involved.  Ignoring the risk of a default for the moment, if you can make 5% on your $60 -- and you can get a five-year 5% CD today -- then if you're willing to pay $60 today for a barrel of oil in five years, you're betting that the price then will be more than $76.58, not that it will be more than $60.  If you believe the price will be less than $76.58, you're ahead to buy the CD now and use the proceeds to buy the oil in five years.  Include a 10% chance that the seller will default on the contract and you get nothing, then your $60 today is a bet that the price will actually be above $85.09.

Of course, that's using simple-minded calculations for the expected value of the future good you get for $60 today.  You can make the model as complicated as you want.  Still, the bottom line for me is that today's $60 price for oil five years out translates into "the market" expecting prices >$75/bbl by then.

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Nate Hagens on January 21, 2006 - 10:15pm Permalink | Subthread | Parent | Comments top
Actually thats not true, because you can put up T-bills or interest bearing notes as margin for the oil futures.

Alternatively, you could put up 10% in margin and keep the other 90% in your 5 year CD and still get all the upside.

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