There has not been much talk of crude production hitting its peak during this recession. The evidence now is real. Investors will need to examine the proof carefully.
According to Marshall Adkins with Raymond James, global oil production peaked in the first quarter of 2008. What is the evidence? OPEC oil production reached a high point in the first quarter of last year, while non-OPEC production peaked even earlier in 2007. Worldwide, total oil production rose to its highest level to date in 1Q2008 (approx. 79.3mmbpd).
Mr. Adkins explains, "It is entirely intuitive to conclude that if both OPEC and non-OPEC production posted declines against the backdrop of $100 plus oil, when the obvious economic incentive was to pump full blast, those declines had to have come for involuntary reasons, such as the inherent geological limits of oil fields."
Marshall Adkins is right on with his reasoning. Why would countries or companies curb production when they could make so much money by producing more oil?
Energy demands have declined, but the reality is they will eventually come back. The supply of oil will then be inadequate to sustain the increased demand.
The fundamental reality is that oil is scarce . Oil producers will be hard pressed to keep up with future demand. E&P companies will be drilling everywhere possible. However, because most drillers cut exploration and production during the recession, they will be behind the demand supply curve. Investors will continue to see the price of crude going higher for years to come.
Monday, May 25, 2009
Saturday, May 16, 2009
Scrap Cap and Trade
Under the guise of regulating industries that generate greenhouse gases, the Obama administration is aggressively pushing an approach called, "Cap and Trade".
The idea is to limit the amount of emissions a company produces. A noble idea. The problem is the method Washington is seeking to implement.
The plan being promoted would require companies to purchase emission credits should they exceed their capped emission limit. The Congressional Budget Office is projecting revenues generated from this proposed bill at a minimum of $50 billion per year, and could quite easily reach $300 billion.
With those kind of revenue dollars at stake, look for the Obama administration to push hard for this legislation. They will then be able to use this backdoor tax on business to pursue their other societal agendas.
The greater concern with this type of legislation is that it will add cost to doing business for any company involved with fossil fuels. Although there appears to be signs of economic recovery, the economy is still stagnant and experiencing lots of pain. American companies will find themselves at a disadvantage as it will become necessary to pass on these additional costs to consumers.
Companies consuming fossil fuels will be more than willing to adapt to new energy sources when the market place provides the new alternatives. Until viable new technologies emerge, it is best that Washington not do further damage to a highly fragile economy by enacting "Cap and Trade".
The idea is to limit the amount of emissions a company produces. A noble idea. The problem is the method Washington is seeking to implement.
The plan being promoted would require companies to purchase emission credits should they exceed their capped emission limit. The Congressional Budget Office is projecting revenues generated from this proposed bill at a minimum of $50 billion per year, and could quite easily reach $300 billion.
With those kind of revenue dollars at stake, look for the Obama administration to push hard for this legislation. They will then be able to use this backdoor tax on business to pursue their other societal agendas.
The greater concern with this type of legislation is that it will add cost to doing business for any company involved with fossil fuels. Although there appears to be signs of economic recovery, the economy is still stagnant and experiencing lots of pain. American companies will find themselves at a disadvantage as it will become necessary to pass on these additional costs to consumers.
Companies consuming fossil fuels will be more than willing to adapt to new energy sources when the market place provides the new alternatives. Until viable new technologies emerge, it is best that Washington not do further damage to a highly fragile economy by enacting "Cap and Trade".
Saturday, May 9, 2009
The 10 Year Note Is Our Inflation Canary in the Cave
Crude futures are up 80% from their $32 low this year. The main drivers of this upward trend has been a combination of increased demand from China, and investors using crude as a hedge against inflation.
China's economic stimulus package is focused heavily on infrastructure spending. Huge government projects to build roads, pipelines and bridges, helped drive the Baltic Dry Index up over 100% to its current 2211. China is also storing vast amounts of crude at what they perceive are low prices.
Investors in crude are also driving prices higher as they seek protection from certain coming inflation. The 10 year treasury yield is now up to 3.3% from 2.5% just a few weeks ago.
A 6% yield on the 10 year note is when things will get very interesting. Investors will find equities not worth the risk, if they can lock in a 6% return by owning debt. Also, should interest rates continue their climb, the US Treasury will find it even more expensive to cover the budget deficit. This will lead to more purchase of debt by the Treasury to try to hold interest rates down. The printing of money in this fashion will lead to higher inflation, which will continue to support higher crude prices.
China's economic stimulus package is focused heavily on infrastructure spending. Huge government projects to build roads, pipelines and bridges, helped drive the Baltic Dry Index up over 100% to its current 2211. China is also storing vast amounts of crude at what they perceive are low prices.
Investors in crude are also driving prices higher as they seek protection from certain coming inflation. The 10 year treasury yield is now up to 3.3% from 2.5% just a few weeks ago.
A 6% yield on the 10 year note is when things will get very interesting. Investors will find equities not worth the risk, if they can lock in a 6% return by owning debt. Also, should interest rates continue their climb, the US Treasury will find it even more expensive to cover the budget deficit. This will lead to more purchase of debt by the Treasury to try to hold interest rates down. The printing of money in this fashion will lead to higher inflation, which will continue to support higher crude prices.
Saturday, May 2, 2009
Proposed Transaction Taxation Bill
Traders are in the cross hairs of newly proposed congressional legislative bill proposals. The greatest harm could come from bill H.R. 1068, better known as, "Let Wall Street Pay for Wall Street's Bailout Act of 2009".
This bill would put a 0.25 percent tax on all securities transactions as a means to pay for the Troubled Tax Asset Relief Program (TARP). The proposal claims $150 billion a year could be raised. The bill goes on to state that the tax would have a negligible effect on the average investor.
In reality taxes have to be paid by someone. Robert Green rightly assessed in Active Trader, April 2009, "Ultimately , the financial-transaction tax could put thousands of traders out of business overnight...Entire Wall Street firms may simply shut down their proprietary trading desks, further drying up liquidity and making the U.S. markets less appealing to the rest of the world."
Less liquidity in the energy complex futures markets will mean greater volatility swings in crude, diesel and gasoline spot and futures prices. Individual traders, trading groups and hedge funds will move their trading away from US markets to more liquid foreign markets.
TARP eventually needs to be paid off. However, taxing transactions will not be the intelligent method to dispose of this liability.
This bill would put a 0.25 percent tax on all securities transactions as a means to pay for the Troubled Tax Asset Relief Program (TARP). The proposal claims $150 billion a year could be raised. The bill goes on to state that the tax would have a negligible effect on the average investor.
In reality taxes have to be paid by someone. Robert Green rightly assessed in Active Trader, April 2009, "Ultimately , the financial-transaction tax could put thousands of traders out of business overnight...Entire Wall Street firms may simply shut down their proprietary trading desks, further drying up liquidity and making the U.S. markets less appealing to the rest of the world."
Less liquidity in the energy complex futures markets will mean greater volatility swings in crude, diesel and gasoline spot and futures prices. Individual traders, trading groups and hedge funds will move their trading away from US markets to more liquid foreign markets.
TARP eventually needs to be paid off. However, taxing transactions will not be the intelligent method to dispose of this liability.
Friday, April 24, 2009
It Takes Two to Seasonally Contango
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.
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 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.
Subscribe to:
Posts (Atom)