Monday, March 9, 2009

Spot Life CL Apr 09

The reported causes of the first 10 days that the CL Apr 09 contract was front, or spot, month is below. The main story for that time was twofold: more bad news on the economic front and analyst estimations that OPEC had made good on as much as 85% of its supply allocation reductions made in the December 17 meeting. Most OPEC members sounded as if they were ready to cut further in the March 15 meeting in Vienna, though Iran, very atypically, suggested that "a solution" would be proposed at the upcoming meeting which would not require further cuts on the part of the cartel. Russia indicated that it would present some sort of proposal for cooperation at the meeting with the cartel, saying that its interests were completely aligned with the organization in the matter of supply.

The Obama Administration made some conciliatory moves in the Middle East, including dispatching two officials to discuss the situation with Syria, following on the French initiative and indicating that they were interested in bringing Iran into "big tent" discussions on Afghanistan. Saudi Aramco sent its first cargo of oil to its joint venture refinery expansion project in Fujian and the National Reform and Development Committee approved a slew of further refinery expansions and greenfield construction, including a potential plan with Rosneft in northern China.

The general economic news was very bad everywhere with Japan reporting a nearly 50% drop in exports in January. South Korea announced exports fell a further 17% in February after dismal showings in the last couple months. German industrial orders also contracted sharply. CDS spreads on a wide variety of sovereign and private debt climbed precipitously. Natural gas in the US fell below $4/MMBtu (~ $23.20/b on a Btu basis) primarily as a result of declining industrial demand.

The giant contango of 2008 continued, though it narrowed considerably from March 2. The one year differential fell from $13.09/b on February 23 to $8.10/b on March 6, or 38%.

After spending a long time at a premium to CL, front month Brent finally dropped to a small discount to front month CL--Brent is historically usually at about a $1-2/b discount to CL/WTI. (The controversy over CL's vulnerability as a price discovery mechanism for the US crude market continued to boil, with the CME announcing that it would have Bob Levin, its Managing Director of CME Group Energy Research and Product Development, lead a 7 hour on line seminar on CL on Thursday to discuss, and presumably defend, the CL contract. Platts proposed another pricing benchmark--the Americas Sour Marker.)

CL Apr 09 exhibited no linkage to the €/$ interbank exchange rate--and I suspect that the past perceived linkage is in a large part due to oil exporting nations purchasing large numbers of euros in order to keep their own currencies from appreciating too steeply--meaning that it would only exist as the price went up and would be led by crude, not the euro. Crude climbed 18.4% between February 23 and March 6. The euro fell by 0.3% from February 21 (a Saturday) and March 6.

Below is a chart of CL, the Russian ruble, Kazakh tenge, and the Nigerian niara percent change from close Jan 1, 08. Astana never really allowed the tenge to float much against other currencies, Moscow and Nigeria have both taken steps recently to reduce speculation against their currencies by domestic banks. (Moscow was especially irked that apparently monies given the banks to bail them out of the current crisis were used to speculate against the ruble.)

On March 6 the April 09 NG contract fell to $3.945/MMBtu (and the ICE Apr NG contract fell to about $3.9626/MMBtu at interbank exchange rates) mostly on the back of a decline in industrial demand. Some analysts forecast that the US NYMEX price might fall as low as $3.50/MMBtu (~ $20.30/b on a Btu basis) over the course of the year and then, on the back of increasing LNG supply, new US supply, and the steep decline in industrial demand to as low as $2/MMBtu (~ $11.60/b on a Btu basis.) Heating oil and diesel (which are nearly identical) cracks have fallen as the price of natural gas declines, though forward differentials are still pretty healthy. RBOB prices arguably resisted further declines in crude prices at the beginning of March, with the price of crude then chasing the crack--as expressed by Apr 09 RBOB - Apr 09 CL--back up.

However, the forecast relative competitiveness of heating oil versus natural gas has not translated into lower heating oil prices for delivery in the winters of 2009-11.

Commitment of traders reports would seem to indicate that the market is unclear of which direction it will go next--positions net long or short account for 0.32% of the market. Even with another OPEC cut (or Russian cooperation, perhaps the "solution" Nozari alluded to) it is unclear to me just where you will see the demand growth or storage availability to see large price gains near term. (If you look at the commitment of traders report for futures and options combined, there is a larger indication with 2.68% of open interest being held by traders net short or long. Given that commercials short to hedge against lower prices and non-commercials are long, the market would be signaling upwards price, but it is still a small share of the traders, given 2008.)

That said, volatility is extremely high just now, with 17 days since January 1 of price changes of 5% or more. Below is a chart of volatility for front month to month 12 delivery for CL from the beginning of the year until March 6.

As you can see from the graph below of price volatility since 1984, we have had more days with price moves of 5% or more than all but four years since 1984 in the first 65 days of 2009. Average volatility for the front month contract has been 4.365% for the first 65 days, well above average volatility for any given year from 1984 on. (Obviously that is not an apples to apples comparison, but I think it's still noteworthy.)

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