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Chris Cook  

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  • Record Breaking Contango Suggests Higher Oil Prices for 2011 [View article]
    @ Carl

    Oil producers are like any other rentier eg a landlord and will always attempt to maximise their rent.

    It makes no sense while dollar interest rates are at zero % for oil producers to pump all out, thereby depressing the price, and then to exchange their potentially more valuable oil for dollar-denominated IOUs yielding zero %.

    They are much better off - if they have no urgent need for the dollars - to leave the oil in the ground, and while almost everyone else in OPEC is desperate to cash in, I am quite sure that this profit maximisation strategy informs the Saudis' current market operations.

    As for Ferdinand's 'too high', well, it's all relative as you say.
    Sep 18, 2010. 01:36 PM | Likes Like |Link to Comment
  • Record Breaking Contango Suggests Higher Oil Prices for 2011 [View article]
    @ ferdinand

    Whether or not analysts and their expectations have a role in futures prices is not really the point, although I agree they must have some minor influence in the short term. The point is that whether or not the price of crude oil will be higher or lower in 2011 is unrelated to anyone's expectations now.

    Re OPEC, they are currently in the position of controlling a very fragile (and possibly more apparent than real - I do not believe Saudi figures for a minute) monopoly position which is subject to even trivial demand shocks, and they are able to manage this position - and apply an oil/dollar 70/80$ bbl pegged range - through 'open market operations' in the forward market.

    The current deep contango, and high level of product stocks, suggest to me that OPEC now has very little room for manoeuvre and that the demand shock from the approaching double dip may be the big wave that overturns a crude oil market which is very much analogous to an unstable RoRo ferry sailing calm seas with its car deck awash.

    If so, we would see crude oil collapse as it did before, with an over correction below a 'lower bound' I see as at about $40/bbl. After a hiatus as demand picks up again then for as long as dollar interest rates are at the zero bound, producers will use ETF money to pump the prices back up again to the 'upper bound' of demand destruction.

    Rinse and Repeat.
    Sep 18, 2010. 08:15 AM | Likes Like |Link to Comment
  • Record Breaking Contango Suggests Higher Oil Prices for 2011 [View article]
    "Contango doesn't guarantee higher prices, but it shows that analysts believe strongly that economic growth will accelerate enough in 2011 and take oil demand higher. And they may be right."

    Futures prices have very little to do with analysts' expectations and a great deal to do with hedgers' fears.

    The basic purpose of crude oil futures was to enable producers to hedge their physical sales requirements, and refiners to hedge their physical purchase requirements.

    In neither case has expectations anything to do with it: hedging is about fear.

    Of course, producers and consumer hedging alone is not enough for a particularly liquid market, so we get market-makers, hedge funds and other speculators who act as trading intermediaries to put their capital at risk in search of a transaction profit.

    But for some time now we have had ETF money in the market buying futures. This is NOT speculative money. It originates from investors who are getting out of dollars at zero interest, and getting into almost anything else, income-bearing or not - as a 'hedge' against inflation.

    ETF investors generally are not looking for a transaction profit - they are looking to avoid a loss. In a nutshell, they are off-loading dollar risk in favour of crude oil risk, which is precisely the opposite of what an oil producer is doing when he hedges. That is why ETFs are good for liquidity.

    They are - unlike true speculators - 'long only', and their massive presence in the market is enabling producers both to monetise the oil they store for free in the ground and to keep the oil price comfortably supported maybe $30 bbl higher than it would othewise be.

    All these guys expect is that the dollar will decline relative to oil, but the level of contango has nothing whatever to do with their expectations and everything to do with what is known as 'cost of carry'.

    Unlike a 'backwardated' market, where the difference between spot and later months is unlimited, a contango is limited by how much it costs to store and insure the oil, and - most importantly - to finance the 'carry' over time.

    That is why we see the oil price curve in contango mirroring the dollar yield curve right out into the distant future. The reason for the depth of contango is probably the lack of availability of storage and therefore nothing to do with analysts' expectations.
    Sep 17, 2010. 01:35 PM | 5 Likes Like |Link to Comment
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