Saturday, November 1, 2008

Spot Life: CL Dec '08

Here is the reported causes table for the first eight days Dec '08 has been the front month contract (its "spot life.") Although the major traditional event was OPEC's decision to reduce their overall quota by 1.5 mb/d, most of the news has been about the teetering economies of the world, suggesting lower demand, which still appears to outweigh the supply reductions. Also big news regarding the Kashagan field in Kazakhstan, several refinery expansions have been shelved, one in Brazil going ahead, and renegotiation of LNG prices from Indonesia to CNOOC's terminal in Fujian.

Front month versus the Euro/Dollar exchange rate (interbank.) The price of light sweet went up about 1.6% from October 22-31; the Euro fell about 1.5%. Looks like crude led the Euro up in the second half of the period considered, but both are likely reacting to the ginormous number of dollars entering the money supply.

CL Dec 08 is still in full curve (or "perfect") contango, where every single contract is less expensive than the one maturing at a later date in time. This is very unusual. The contango is still incredibly steep, and the front vs Dec '16 differential has actually widened from $20.03/b on October 22, when Dec '08 became spot/front month, to $24.46/b on October 31. Typically the differentials between front and late months are much smaller. The differential between the Dec '08 and Dec '16 contracts is now fully 36% of the front month price!

I do not think you can write off this differential as technical given how long it's been in place now. The market sees a higher price long-term. Perhaps it is a bet on inflationary pressure, perhaps supply, maybe a combination of the two, maybe something else, I don't know.

You can see from the chart below showing the overall open interest in futures vs futures and options combined that the trend in the number of people holding sweet light futures is down from the beginning of the year. The last peak came in the middle of May when there were about 1.5 million active contracts. The reason for the downward trend is price which peaked in the Summer, as you might expect. However, the open interest in futures and options combined has grown by about just as much as open interest in futures alone has dropped, so that may indicate demand suppression as opposed to demand destruction, so to speak. The last report saw an uptick in open interest in both categories--a 3.6% weekly increase in futures and a 7.5% increase in futures and options combined. The trend is still downwards, though, and a substantial portion of new positions are held in thinly traded contracts fairly far out on the strip.

The following chart gives a sense of where "commercial" traders were in relation to "non-commercials" for the year of 2008 so far. It suggests to me that if you assume commercial trades were for the purpose hedging, for the first half of 2008 they were hedging against a fall in the price of oil, meaning that both commercials and non-commercials were expecting the price to rise. You'll note that non-reported positions were quite high in the middle of the Summer and net short, so we do not know if commercials or non-commercials were under-reporting shorts. In late June both commercials and non-commercials were net long insofar as reported positions go! I'm not entirely sure whether you can deduce anything from that, but the price peaked in July, I believe. It now looks like perhaps the commercials are hedging against a rise in the market--meaning that the market is set to continue to fall.

The number of net trades for either category of trader long or short is a small percentage of total open interest, usually from 0-2% of the market. In the first half of the year it averaged 4%--though this number is suspect given the high percentage of positions where we do not know whether they were held by commercial or non-commercial interests.

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