Tradesense

What's Cooking with the Oil Price Contango?

Jake

Consensus estimates on oil prices are still very bullish. These estimates indicate a USD82/bbl and USD90/bbl for 2010 and 2011, respectively, and even reflect a higher price assumption at USD96/bbl for 2012. Looking at the history of consensus estimates, it is found that current oil price estimates are higher than what they were one year ago. While in September 2007, the oil price assumption averaged USD62/bbl for 2009-12, the current assumption averages 43% higher at USD89/bbl. The current high oil price assumption it appears reflects high oil prices seen in 2008.

I believe further scope exists for these assumptions to come down, as oil prices continue to remain lower going forward. This is similar to what had happened after the 1979 oil shock, when oil price assumptions continued to fall with price assumptions drifting lower during 1982-97.

Historically, every recession since the early 1970s has followed a period of high oil prices. However, the excessive leverage and under-pricing of risk are also central to the current downturn. In the current down turn, oil prices played what has been described as a ‘contributing role’ by reducing consumer spending and confidence, and placing the burden on many businesses, both large and small.

In the early 1970s, the global GDP was growing at annual rates of 6-9%. The so-called first oil shock, which took place in 1973, restricted the GDP growth in 1974-75 to less than 2%. Similarly, the GDP grew at 6-7% during 1976–79, the year of the Iranian revolution and the accompanying second oil shock. For 1980–82, the average growth was again below 2%. From 1983 to 1988, it recovered to around 6%.
After 1980, oil prices began a 6-year decline, which culminated with a 46% price drop in 1986. This was due to reduced demand and over-production, which caused cracks in OPEC’s unity. Oil prices remained on a low trajectory during 1983-2003. Prices saw a small spike again in 2000. In 2001, the GDP growth registered a similar drop.

The highest average annual oil price prior to 2004 was USD36/bbl in 1980. For 2004, 2005, 2006 and 2007, the annual price of WTI crude averaged USD41/bbl, USD56/bbl, USD66/bbl and USD72/
bbl, respectively, as the GDP continued to grow at 6-7% over this period.

Oil prices remained low for 20 years after the 1981 recession.

Given the global synchronization of this slowdown of much higher severity and the lack of consumer spending power (which was a savior in the past) I would tend to believe that soft oil would prevail for a reasonably long time fluctuating between $25-30 to $50-55.

WTI's importance will remain unless US relative consumption falls drastically. It will help if Cushing can address the logistics problem.

I'am sure there will many other views which could throw more light to it.



On Jan 20 03:09 AM Jake Berzon wrote:

> Thanks for the explanation - it makes sense. I was starting to wonder
> why WTI has remained so cheap for so long vs. Brent. I have never
> seen this happen before!
>
> What is your prognosis on the price level stabilization? Will the
> price of WTI oil rise to match futures contracts, or will all this
> storage cause a further drop in prices that will spill over to Brent?