Tuesday, December 16, 2008


Is there any other commodity that nearly everyone in and out of the market has an opinion on? It’s almost enough that I hesitate to add my small voice into the howl of market opinion. But that’s never really stopped me…

Other websites and news outlets have already reported on vehicle miles traveled. Here are two charts showing vehicle miles traveled (VMT) both on a rolling 12 month basis and with the price of crude since 1986. There is clearly a regular monthly variation and this year is no different in that regard.

This year, the percentage increase from September to October in VMT was 7.27%, as opposed to an average of 5.62% in the 5 years prior, which certainly would indicate that the plunge in gasoline prices has allowed for more driving. The year-over-year percentage change level has not been seen in the data series since the late ‘70s timeframe, which is saying something in this discussion.

But obviously the VMT is not the majority of the story, considering oil continued to accelerate upward for a few years even as the year-over-year mileage driven started to slump. For a second piece of the oil price puzzle, NYMEX has to be checked.

Since last September, I have been tracking open interest of crude contracts on NYMEX since there is no source of this historical data that I was able to locate. Once a couple of months of data were collected, the pattern in open interest was apparent as seen in this chart:

Peak open interest since last May has fallen off considerably on a year-over-year basis reflecting liquidation of a portion of these contracts rather than the continued rolling of them from month to month. Back in July of 2007, I was fortunate to stumble upon Hussman’s article titled, “The Outlook For Inflation and the Likelihood of $60 Oil.” In it, he stated:
“In my view, the problem will emerge a few months from now, as a) economic demand softens further, b) planned production hikes actually emerge, and c) weakening price momentum encourages speculators to close long positions instead of rolling them forward. At that point, I expect that net speculative positions will plunge by 10-15% of open interest and we'll see a sudden glut on the market for spot delivery. It should not be surprising if this speculative unwinding takes the price of crude below $60 a barrel by early next year.”

This statement was made when oil was still above $130/bbl and so really is impressive in my mind. But the interesting thing is that the open interest didn’t take until the fall to unwind – it actually began in July. The chart here shows the peak open interest levels and the year-to-year percentage change. The February contract peak should be occurring in the next week as the January contract nears assignment. I don't expect that there will be significant additional liquidation.

Additionally, there is the subject of contango vs. backwardation. For almost the entirety of the run up in crude oil pricing, the spread between the front month contract and 6 months out was negative (backwardation) meaning that delivery sooner was worth more than delivery later. However, as the peak in oil price approached this 6 month spread started to flatten out and eventually switched over to contango. Last week, the 1 year spread in contract pricing reached $15/bbl meaning that you could buy oil for delivery in the near month, stick the oil in a tank and sell a contract to deliver that oil in one year’s time for $15/bbl more than you paid – a decent return assuming warehousing costs are not too much. At this point though, it looks like this spread is narrowing a bit which would imply some increase in price or at least a bottom.

Another item worth mentioning, the couple of oil stocks that I track in my oil spreadsheet – XOM & RIG- have been moving up in the last weeks, even as crude has fallen. RIG, a bit more than XOM, has generally traded in anticipation of crude price movement. The caveat here is that RIG has been crushed from its high and still apparently has its capacity contracted for 4 years so some of the rebound could simply be reflective of this fundamental economic health. (Peak oil or not, oil is almost indisputably getting more difficult to lift out of the earth.)

Finally, there is the weakening dollar that has recently breached a resistance level. Where this ends up, I’m not sure considering that there aren’t many other regions that are in considerably better fiscal health than the US. During the run up, it seems evident that using commodities as a store of value against dollar depreciation was a typical trade. However, it also seems likely that many of these players forgot that oil, like all commodities, is subject to supply and demand considerations and if demand side collapses so too will the price.

At any rate, this is all a rather long-winded way of making my case for oil having formed at least a mid-term bottom. I hate to be on the same side as GS on this but there it is.