Wednesday, November 12, 2008

Spot Life CL Dec 08 pt. 2

The financial crisis continues to be the reason most given for the direction in oil price, below you'll find the reported causes table for Nov 3-12. (If you click it on the table it become legible.) The other central event would be the announcement of a $586 billion stimulus plan which put a bit of a lift under all commodity prices for a day. China also announced that they were planning on enlarging their strategic petroleum reserve considerably.

It looks to me that the Dollar / Euro exchange rate is following--so to speak--moves in crude for the last two weeks or so. Very volatile, but from my totally arbitrary calendar (Nov 1-12), the Euro has lost about 0.03% of its value against the dollar (at interbank rates.) During that time oil has lost 12% of its value.

CL is still in perfect contango along the entire curve! The differential between the contract for December 2008 delivery (the front month) and December 2016 delivery is $29.13/b widening even further from $20.03/b on October 22, when Dec '08 became spot/front month, and a differential of $24.46/b on October 31. The differential between front month and December 2009 delivery--a bit more than a year's difference--is $10.01/b. That differential has widened from $7.07/b on October 31 and $6.13/b when CL Dec 08 became front month on October 22.

Wild. I'm not that seasoned an observer, but I've never seen (or heard) of a differential of this size before. $4/b contangos are generally considered huge--this is a $29.13/b differential, the differential between is front and last month contracts is more than 50% of the price of oil today.

This is unusual because anyone looking to make money will buy front month oil and at the same time sell contracts for delivery at a later date. Thus under normal circumstances contango puts tremendous upward pressure on the front month contract as people buy it and tremendous downward pressure on contracts further out as people sell--at the same time. The buyer takes the oil he gets from the front month and puts it in storage--he has already guaranteed a profit having contracted to deliver the oil to another buyer at a later date. The profit is then the differential between the price of the front month contract and the month he contracted to sell that oil at minus the storage cost. (Relatively speaking, storage is not that expensive.) Much smaller contangos than the one we are currently observing do not last very long because people can make huge profits on much smaller differentials, given large enough financial resources. So, generally speaking, there are plenty of people in the market looking to profit on these discrepancies which makes them disappear pretty quick.

One potential reason for the situation would be a lack of storage. But if you take a look at the EIA's latest stocks data it appears that stocks are at their historical average and not even near the top of that.

Another is that low market volume is slowing down the natural move back to backwardation. Perhaps, but open interest (the number of contracts for oil) has gone up in the latest data (for November 4th) by 52,207 or nearly 5%.

Another is that banks are refusing to finance transactions required for this (for example, to rent storage for 12 months) because they want to be as liquid as possible.

Another is that the market believes that the current price of oil is much lower than fundamentals would suggest and that the price will inevitably go up going forward.

So far, a combination of these last two seem the most reasonable explanation to me, though I am ready to be enlightened if I am wrong.

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