When crude futures pricing is upward sloping, prices in succeeding delivery months are progressively higher than in the nearest delivery month, investors refer to this type of market as contango. This is the normal state of the crude market, similar to the bond market's normally upward sloping yield curve. However, the economy has been anything but normal lately. Demand estimates for crude seem to be lowering each month. Why are we not seeing backwardation of the crude futures market, where prices in succeeding delivery months are progressively moving lower than the nearest delivery month?
The answer lies in understanding the seasonality of crude prices. There are many factors every day affecting crude pricing. The two most important this time of year supporting contango are the end of refinery maintenance season and the soon arrival of hurricane season.
Refiners of petroleum products take advantage of the end of winter heating season and lower car driving in the U.S.A. to lower production capacity of diesel and gasoline, so that they may perform routine maintenance on their facilities. Now it is time to ramp back up for agriculture, construction and increased summer driving. In order to produce more product, refiners must purchase more crude, which lowers supply and raises spot pricing as well as outer month futures, as end users seek to lock in contracted supply for the summer. We are seeing evidence of this from WTI crude stored in Cushing, OK finally beginning to record lower inventory supply, as the Midwest prepares for agricultural planting.
The other partner supporting crude contango is the weather man. Soon we will be receiving hurricane activity predictions for the 2009 hurricane season. Heavy users of diesel and gasoline in the southern states cannot afford to be without fuel supply due to a hurricane disruption. They begin locking in supply contracts now, with many locking in fixed pricing as well. This activity drives the outer months higher than near month futures.
Traders looking solely at fundamental current over supply will be tempted to short the near month spread. That trade may work if we receive another round of devastating economic news. The higher probability trade is to look at seasonal factors and plan your trading accordingly.
Friday, April 24, 2009
Friday, April 17, 2009
NYMEX WTI Futures Divergence from Retail Gas
In January thru March of 2009 consumers witnessed retail gas prices move from an average $1.61 to $1.96, while NYMEX crude futures were range bound with no upward trend. How can this be possible?
Understanding this phenomenon requires knowing what type of oil the NYMEX futures are based. West Texas Intermediate (WTI), a light or sweet crude spec, with delivery at Cushing, OK, is the particular type of oil being traded on NYMEX. Local conditions at this delivery point, as well as larger market trends are mainly what is being reflected in the WTI futures price.
Therefore, the WTI NYMEX futures contract sometimes is not an accurate indicator of retail gas price movements.
There are two key elements in understanding how retail gas is priced. First, WTI is not the only kind of crude oil being refined in the United States to produce gas. Price rises in these other types crude accounted for half of the price increase in gas between January and March.
The other piece of the puzzle is overall supply and demand. Crude is used to make a variety of products. Overall demand for these other products will affect the price of crude and ultimately the price of gas. Gross gasoline margin, the difference between the wholesale (spot) price of gas and the spot price of crude, is the main indicator of divergence between the two markets.
In 2008 gas margins were weak, encouraging refiners to produce higher margin distillate products such as diesel. As supply of gas fell, gross gas margins began to increase in 2009. As a result, retail gas prices increased.
Retail gas prices will continue to depend on gross gas margins in 2009. However, as long as oil inventories at Cushing, OK continue to remain at historically high levels, the NYMEX WTI price may continue to be a misleading indicator for the price of retail gas.
Understanding this phenomenon requires knowing what type of oil the NYMEX futures are based. West Texas Intermediate (WTI), a light or sweet crude spec, with delivery at Cushing, OK, is the particular type of oil being traded on NYMEX. Local conditions at this delivery point, as well as larger market trends are mainly what is being reflected in the WTI futures price.
Therefore, the WTI NYMEX futures contract sometimes is not an accurate indicator of retail gas price movements.
There are two key elements in understanding how retail gas is priced. First, WTI is not the only kind of crude oil being refined in the United States to produce gas. Price rises in these other types crude accounted for half of the price increase in gas between January and March.
The other piece of the puzzle is overall supply and demand. Crude is used to make a variety of products. Overall demand for these other products will affect the price of crude and ultimately the price of gas. Gross gasoline margin, the difference between the wholesale (spot) price of gas and the spot price of crude, is the main indicator of divergence between the two markets.
In 2008 gas margins were weak, encouraging refiners to produce higher margin distillate products such as diesel. As supply of gas fell, gross gas margins began to increase in 2009. As a result, retail gas prices increased.
Retail gas prices will continue to depend on gross gas margins in 2009. However, as long as oil inventories at Cushing, OK continue to remain at historically high levels, the NYMEX WTI price may continue to be a misleading indicator for the price of retail gas.
Friday, April 10, 2009
The Importance of Transportation Indeces
Twelve years before the Dow Jones Industrial Average (DJIA) was conceived, Charles Dow relied on his Transportation Index to understand how the overall market was trending. Developed in 1884, and consisting mainly of railroad companies, the Dow Jones Transportation Index (DJTI), alerted investors to the overall strength of the economy.
Based on the concept,"if you make it, you gotta move it," the DJTI is still used by equity investors to confirm price trending of the DJIA. If the DJIA is moving up, and the DJTI is staying flat, or heading lower, the divergence of the indices indicates the DJIA movement higher is a head fake.
Another important index energy complex traders need also to closely observe is the Baltic Dry Index (BDI). Designed to track daily freight rates of dry commodity cargo ships, the BDI has great value in alerting investors to the beginning stages of economic slow downs, and the commencement of economic growth.
Energy traders who followed both the DJTI and the BDI were rewarded by knowing when world wide economic growth had peaked last year, and when the recovery began to take hold this year.
Based on the concept,"if you make it, you gotta move it," the DJTI is still used by equity investors to confirm price trending of the DJIA. If the DJIA is moving up, and the DJTI is staying flat, or heading lower, the divergence of the indices indicates the DJIA movement higher is a head fake.
Another important index energy complex traders need also to closely observe is the Baltic Dry Index (BDI). Designed to track daily freight rates of dry commodity cargo ships, the BDI has great value in alerting investors to the beginning stages of economic slow downs, and the commencement of economic growth.
Energy traders who followed both the DJTI and the BDI were rewarded by knowing when world wide economic growth had peaked last year, and when the recovery began to take hold this year.
Saturday, April 4, 2009
The US Treasury Impact on Crude Price Direction
The US Treasury will need to borrow $3.25 trillion this fiscal year, including sales to replace maturing securities. This will place significant over supply pressure on debt markets. Treasury notes dropped for a second week as investors show a growing concern over the vast supply coming on board.
The US Treasury is attempting to prop up the debt market by buying back $300 billion of supply. However, this is only delaying the inevitable rise in interest rates and decrease in debt prices, that will occur when the US ceases its debt buy back spending spree at fiscal year end six months from now .
Proof of trader skepticism is evident in the recent drops in T-notes the last two weeks, despite the first US Treasury debt buy backs since the 1960's.
Because of this enormous current account deficit, we are dependent upon foreign capital to increase demand for our debt. This presents an extremely bearish environment for the US dollar. Since crude pricing is in US dollars, a weaker dollar means a higher price will be paid for crude.
Crude supplies are at record peaks, with demand falling. However, alert traders are looking out six months ahead to when the Treasury fiscal year ends, and thus the end of debt buybacks. They are positioning themselves now for the inevitable US dollar weakness and energy complex bull run.
The US Treasury is attempting to prop up the debt market by buying back $300 billion of supply. However, this is only delaying the inevitable rise in interest rates and decrease in debt prices, that will occur when the US ceases its debt buy back spending spree at fiscal year end six months from now .
Proof of trader skepticism is evident in the recent drops in T-notes the last two weeks, despite the first US Treasury debt buy backs since the 1960's.
Because of this enormous current account deficit, we are dependent upon foreign capital to increase demand for our debt. This presents an extremely bearish environment for the US dollar. Since crude pricing is in US dollars, a weaker dollar means a higher price will be paid for crude.
Crude supplies are at record peaks, with demand falling. However, alert traders are looking out six months ahead to when the Treasury fiscal year ends, and thus the end of debt buybacks. They are positioning themselves now for the inevitable US dollar weakness and energy complex bull run.
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