Sunday, January 18, 2009

Oil Anomalies

Interesting things in the world of crude are afoot! The spread between the February (front month) and March contracts reached a fairly impressive mark of $8.14 on Thursday before falling back to a still high $6.06/bbl. Pretty impressive. The chart to the right shows what the normal spread between these two contracts has been in the past year and a half. Up until a point in early summer of 2008, crude prices were actually in backwardation or had a flat spread. What we see now is a massively changed market reflecting contango (or super-contango as I have seen it written recently). The 6-month and 1-year spread between contracts closed on Friday at $16.28/bbl and $22.59/bbl respectively. These are very unusual numbers that will be revisited.

The next somewhat anomalous thing is that open interest in the March contracts has blown up in the past week. Since oil crested this past summer, the monthly peak open interest has been falling backwards on a year-over-year basis pretty steadily since. I talked about this a bit in my first oil post. The open interest had seemed to be behaving in a somewhat predictable manner until the last week when I noticed the March contract's open interest rocketing up to last year's peak level for the March contract. Just predicting based on monthly growth from last year a jump in peak open interest to perhaps 325K contracts. Instead, the Feb contract has not yet been assigned and there are already 382K contracts available for trading - roughly equivalent to last year's and a 33% jump from last month's peak.

So what is going on here? First, the NYMEX WTI contract is delivered at Cushing and Cushing is functionally full with negligible storage remaining. The belief is that this is artificially depressing prices. There are numerous commentators pointing out the divergence between WTI and Brent pricing, claiming this as further evidence that WTI is not representative of "real" market prices. I'm not quite as satisfied with this explanation. Here's the chart of spot prices for WTI and Brent since 2005. The entire set from PRI (see link to the right) goes back to 1987 and during that time WTI generally traded at roughly $1.20/bbl premium to Brent. Further, there are clearly long periods where Brent trades at a premium to WTI. Being an amateur, I don't really know what the significance is but this price divergence just doesn't appear all the significant when put in context with the past years. Articles such as this one by Chris Cook (former IPE compliance guy) make me a little skeptical about how much weight the Brent prices should carry but also questions the usefulness of WTI at NYMEX.

Anyhow, there have been lots of articles about the Brent vs. WTI pricing (see links at bottom) and several mentioning the super-contango market currently in effect. There have also been lots of stories about oil speculators leasing out freighters in order to create floating storage. (Also in the links at bottom - FRO is mentioned specifically.) I found this interesting because this is not the first time this type of oil "arbitrage" has been thought up. Prior to the oil bubble being popped, none other than Morgan Stanley had ahem, floated this scheme in May 2007. How that worked out for them, I have no idea. So the resurgence of these reports is interesting to say the least. But the one thing I've not seen mentioned anywhere is the surge in open interest in the March contracts. On the one hand, it would seem to point to a speculative fervor, though it is unclear if that will translate to higher prices. It will be quite interesting to see if the March contracts fall once Febs are assigned, given the yawning gap. I suspect it will also be worth paying attention to when all those extra contracts start to get liquidated. After all, oil is still subject to supply and demand no matter how quirky the market pricing for a period of time. I would welcome any comments or thoughts on what this large spike represents.
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