Update: Crude closes at another record:
Light, sweet crude for November delivery rose $1.48 to settle at $87.61 a barrel on the New York Mercantile Exchange. Oil prices reached a new record trading high of $88.20 earlier in the session and eclipsed the record close of $86.13 a barrel set on Monday.
Meanwhile, demand concerns have risen since reports in recent days from the Energy Department, the International Energy Agency and the Organization of Petroleum Exporting Countries have suggested oil supplies are flat or falling as demand is growing.
The surge in prices has also attracted lots of speculative investment money, further driving prices higher. And the tight supply and demand situation magnifies the price effect of geopolitical tensions, as there is less spare supply available globally to cover a disruption from someplace like Iran, Nigeria or Venezuela.
The falling U.S. dollar has also played a role, as oil worldwide is priced in dollars. Oil producing nations have less incentive to ramp up output if the buying power they receive per barrel is declining, and foreign consumers have less incentive to reduce demand if oil is, relatively, getting cheaper for them.
——————-
With oil prices closing above $86 yesterday, a number of people have asked if I am starting to sweat my $1,000 bet that crude won’t make it to $100 this year. In order to reach that level, oil still has to advance another 16% in the last 2.5 months of the year. That may not seem like much, but remember that is on top of the already strong run that it has had. I expect people to start taking profits pretty soon, and I think there will be resistance between here and $100. OPEC will also be under pressure to produce more, and if they announce that they will do so, it could drop the price very quickly.
As far as the bet goes, as I told many people when I made it, I am hedged pretty well. As oil prices increase, my company’s stock price increases. So, if oil reaches $100, I will earn more than $1,000 from the stock appreciation. Of course the worst possible scenario is for oil to just crack $100, and then retreat back to $75, taking my company’s stock price down with it.
The Oil Drum is conducting a poll to see where readers think oil prices are headed:
By more than a 2 to 1 margin, readers think oil prices will reach $93 before they reach $79. I voted for $79 before $93.
Yesterday’s OPIS report covered this story at great length. They also showed that speculators are playing a major role here (I know some don’t believe this, but numbers are provided below). Here are some excerpts:
There was no shortage of bullish headlines to support the crude move but the momentous settle still left analysts scratching their heads. One analyst noted a “tough market to peg,” and a rally that “doesn’t seem to stop.” ExxonMobil’s CEO Rex Tillerson was among the perplexed, telling Dow Jones that market fundamentals don’t support $86/bbl crude oil.
Regarding speculators, the numbers tell the tale:
Friday’s data from the Commodity Futures Trading Commission underscore the difference between mid-October 2007 and the same period a year ago. Data released by the CFTC on Friday show that large “non reportable” positions among long traders increased by nearly 8-million bbl for crude oil. Meanwhile, funds on the short side liquidated about 4.7-million bbl worth of contracts.
The result is a “net long” number that shows funds betting on price appreciation to the tune of a net position of 69.2-million bbl. Interestingly, this came on a day where Energy Secretary Bodman acknowledged that oil prices are no longer the province of energy companies but instead are within the trading rooms of New York, London, and other worldwide financial capitals.
The year-to-year difference in the bias is staggering. The CFTC report from October 13, 2006, showed speculative longs holding about 159-million bbl worth of crude, but speculative shorts were at nearly the exact same number. The net long position of a year ago was just 301,000 bbl. Hence, the big speculators have a net bet on higher prices that is about 230 times the net bet from one year ago.
The thing about speculators is that they can push the price down as quickly as they pushed it up. They greatly increase the volatility of oil prices.
Here’s a story from Reuters that captures my sentiments pretty well:
Oil prices may be close to near-term peak
NEW YORK (Reuters) – U.S. oil may hit a near-term ceiling soon as market fundamentals should not support prices much higher than the current record $85 a barrel levels, the director of Terra Verte Trading LP said on Monday.
“I’m thinking that $86 or $87 is pretty close to the top with the information we have right now,” said Andy Weathers of the Houston-based fund.
U.S. crude oil futures touched a record high $85.30 on Monday as part of a surge that has added nearly $15 to prices since late August.
Concerns about potential supply shortfalls this winter and the weaker U.S. dollar have helped fuel the rally, while worries over mounting tensions between Turkey and northern Iraq have added geopolitical concerns over the past week.
But Weathers said supply and demand levels do not support a rise much further and a top may be close if geopolitical concerns subside.
“To me, it appears that if we can digest this, the market should sell back off,” he said in a telephone interview.
“I think it is a little overpriced right here.”
Don’t get me wrong. I think long-term, we will see oil prices continue to climb. I just think prices have gotten ahead of themselves at the moment, and is very likely going to back off from these levels for a little while.
Robert,
This can be a little chicken and egg thing. Why are speculators/traders so bullish on oil to begin with? In part, because, like you, they see high oil prices for the foreseeable future due to fundamentals. With very little USABLE spare capacity, both upstream and downstream, the market will react strongly to any perceived potential supply shortfall (e.g., Turkey/Iraq).
So, is some of the recent run-up due to speculators? Probably. But specualtors aren’t keeping prices from being $60. They are more a symptom, rather than a cause, in my personal opinion.
At the same time, gas prices are very low and the shorts rule. Last year several hedge funds went belly-up from gas trading.
Enerfax Daily
With WTI at $86.70 and NYMEX gas at $7.35, gas is priced only 51% of crude oil on a heating value basis. Out in the Rocky Mountain basins prices are really low. This is why companies like Chesapeake have cut back on drilling.
There is no method for the paper markets to correct. In the old days, the Texas Railroad Commission would release more production on to the market or OPEC would act to raise quotas. OPEC members have been diverting oil revenues to social programs and haven’t been investing in new production.
Can someone point us newbies to a good primer on trading energy futures? I’m talking a small amount, maybe $1000 just to get the feet wet. What about spiders and indexed funds? Is such a small amount even worth the trouble?
This gets back to my plan to stabilize oil prices.
I would establish a US oil import fee that would kick in at any time crude dropped below $50. Then I would launch a program to increase US production by 1 million barrels by 2015 by opening the 1002 area and other federal lands. I would declare a 20-year tax holiday, NO federal taxes on new gas to liquids, tar sands, shale oil, or other biofuels, or other alternative fuel producers. Instead of an income tax I would substitute a carbon tax on this new production of $30 / ton of CO2 produced from the production of the fuel. This would ensure there is economics for sequestration.
There is more carbon below the state of Illinois than in all of Saudi Arabia and Kuwait combined. It is time we started developing more of our own fuels and telling the despots to pound sand.
Anon – the last thing we need is your $1,000 screwing up the paper market. But if you must . . . find a book by Peter Fusaro, he (and a few others) pretty much wrote the book on trading energy derivatives.
One of my solutions is to conduct a daily lottery in the paper market where derivitive holders would be forced to physically sell or buy crude and hold it 30 days. This would chase a lot of the stupid money out of energy trading but wouldn’t hurt producers and refiners who are regularly in both the paper and physical market.
Mr. Katy, I would just like to benefit from the fossil boom as much as you and everyone else seems to be. BTW, it wouldn’t be stupid money per se; I’m not a trader but I am an energy consultant for a major city, so it only seems fair, no?
Thank you for the reference.
Anonymous,
Be very careful, futures markets are wicked quick and wipe out money faster then anything else.
If you have to read a book about it you are very likely to get your head handed to you by the market.
Watch your margin calls.
Because of the highly leveraged nature of commodity trading if you get caught on the wrong side of a trade your margin call could be many times the actual investment.
TJIT
yes,
oil like many commodities in long secular bull market is acting as it should. until a competitively priced replacement appears, enjoy the ride.
let’s hope a catastrophe of some type doesn’t occur to interupt/jeopardize a normal historical occurence. this could be a worse alternative.
fran
ANONYMOUS LOOKING TO DELVE INTO COMMODITIES–
advice given by others to be wary/cautious is right on. but if you persue subject try HOT COMMODITIES, jim rogers, random house, 2004. once you have basics down, there are now half dozen ETFs for you to understand/consider. these are based on various indices for types of commodities.
if you know ETF subject, these will make sense.
other sources–
SEEKING ALPHA archives, YAHOO finance, BARRONS.
THESE SOURCES SHOULD LEAD TO MORE.
like any other investment–
know subject, what content you buy, and why you bought.
GOOD LUCK fran–
We are getting into rarified air here. I think it’s even making our friends at Oilwatchdog dizzy. You have to see their latest post to believe it. They are using the high present oil/gasoline price ratio as further evidence of Big Oil nastiness. In other words, they say, gasoline prices are too low!
By the way, the folks over there have introduced censorship. All posts have to be “approved.” I guess my recent ones weren’t. 🙂
Anon 3:20
Caveat: not to be considered investment advice!
Futures contracts are fairly large, for example an oil contract on the NYMEX is 1000 barrels, or $87,000. You can buy a contract (or sell one short) for a small % of the total price, but obviously there’s a big risk that you can be wiped out by a small move in the wrong direction, unless you have enough capital to support the position when more margin is needed.
A new way for small investors to buy commodities is Exchange Traded Funds (ETFs). Here are a few that I’ve heard of:
DBC – a basket of commodities that is heavily weighted with energy components, but also includes agricultural components and metals.
DBE – energy complex including crude, nat gas, and finished products like gasoline and heating oil.
USO – oil only, tracks WTI benchmark.
NGX – natural gas only, tracks Henry Hub benchmark.
ETFs have some problems, particularly tracking errors that accumulate because they have to synthesize a position in the spot market with futures contracts. USO is notorious for not tracking WTI very well. A good place to start looking for info on ETF’s is http://www.etfdigest.com.
The nat gas ETF should have been UNG, not NGX.