PARIS (ResourceInvestor.com) -- As we normally take a look at factors hustling the oil market, like storms, war, debt and fiscal madness, it is time we stopped. Let us have a quick look at where the oil market actually stands at the moment.
In general the market is in backwardation; that is crude oil at around $74 per barrel for WTI is higher than the market expects it to be in the coming months. But the curve, the line of the graph, is in fact very flat. In other words this says two things about where traders and institutions think the oil price is going to go.
Firstly you can say that the market thinks the price is going to stay roughly the same, somewhere between $70 per barrel and $75 per barrel. To be honest this would be a fair assessment to a lot of people. The other interpretation of a flat curve is that no one actually knows where the price of crude oil is going to go. This would also be a fair assessment.
When prices are higher at the front of the curve this generally tends to mean that selling oil is a good bet. If the curve is the other way around storing oil is generally regarded as the better option. After all if oil is more expensive in the future, why not hang on to it?
So right now the market is leaning to say that oil is going to be cheaper in the next few months of the year. There are some good pointers to that. Firstly, the last two years. In 2005 and 2006 in the second half of the year we had two very heavy bouts of shorting, that is betting on the market to go down. The thing that was driving that market, in this columns opinion, was greed.
Oil spiralled down to $55 per barrel in late 2005 and as low as $50 per barrel in 2006. but then, amazingly, it rebounded back to new highs on both occasions, though admittedly this years new WTI high of $77.21 on August 1st was only just over the previous high in 2005. This adds weight to our argument that the shorting was a process by which institutions squeezed out profits for themselves, distorting the reality of oil production and demand.
The fact that we have a flat curve seems to be the market getting ready to do the same thing once again. If you got in on oil at $50 per barrel then you are very keen to see it cut out and grab those tasty profits. There are a few things on the horizon that would make you hesitate - were you to be a trader - that it may go even higher, such as hurricanes and an attack on Iran. Hence we end up getting a flat curve.
There are a few other spanners in the works. More refinery capacity in the United States is going to come back online which will suck up more crude oil. Also last year both Europe and the United States had extremely mild winters which again depressed prices. We may not be so lucky this time.
There is also the worry that various forecasts about demand prove completely wrong. Production has been basically stagnant for the last two years as it appears we are starting to mount the “undulating plateau” so loved by Cambridge Energy Research Associates. If we continue to see demand rising into the fourth quarter of the year then all bets are off. But that is a big if, debt and economic woes appear to be starting to take the edge of the major consumers the United States and Europe.
So, the pensive flat curve, at a time when the oil markets have really been very clam may just be the financial institutions waiting for any problems to go away before performing the same process as both 2005 and 2006.
Remember we said $66.60 per barrel at Christmas time? Well, we will stick by that. Just don’t bet your sub prime mortgage on it just yet.
