Friday September 19 2014 6:11 AM CST
Word Count 689
Trading Paper Barrels
Energy service companies toil to bring in the real Texas Tea, barrel by barrel in the Permian Basin and the Eagle Ford. Traders in New York are a bit more clever; they simply create paper barrels and start trading. Today we look at various aspects of the paper trade and the new reality in Texas.
The Butter and Cheese Exchange of New York began trading in 1872. Later the Exchange did business in potato futures. These trades were subject to such outright manipulation that the Commodity Futures Trading Commission CFTC was created in the early 1970s to ride herd on such frauds. Today it is known as the New York Mercantile Exchange where billions of dollars of energy contracts are traded.
Arbitrage is the process of taking advantage of price differentials in the same commodity in different markets or at different time intervals. We have tracked the drop in the price of West Texas Intermediate to Thursday’s close at $92.03. However the October 2015 contract is trading for $100.55. So traders can buy the near term contract at $92.03 and sell one year forward at $100.55. The trader pockets the $8.52 difference. Even if the price of oil futures is higher when October 2015 arrives, since the trader is ‘long the spot market, he is able to ‘cover’ or close out the trade and provide product to the seller.
This has resulted in a phenomenon not seen since the price collapse of 2008. Then oil plummeted to $35. Sensing this could not continues, firms began leasing tankers to store the cheap oil, hoping to profit from and eventual price rise. For example Sinopec has leased the 3.2 million barrel supertanker TI Europe. Sinopec is storing oil there. Speculation has it that there are now some 25-50 million barrels in tanker storage.
Two weeks ago in this space I reported that supply was simply outpacing demand. The result was lower oil prices, a prediction that has come true. While storing oil to take advantage of higher future prices may be a clever trade, it is hard to see how this will eventually raise oil prices. When there is more and more of a commodity in storage but less demand the price usually has to fall for the market to absorb the supply.
In a related development we have the latest report form the Commitment of Traders COT regarding gasoline futures. This group has been betting on lower gasoline prices since 2005. Commercial traders are seen as the ‘smart money’ as opposed to the public. The commercials are now down to one of the lowest short positions since 2010. This means fewer and fewer of the sophisticated crowd are expecting lower gasoline prices. In the past this has been a precursor to higher gasoline prices.
One reason for covering their short positions is the recent rapid rise of the US Dollar. With uncertainty all around the world, traders have flocked to the US buck. The Russian ruble, the Australian Dollar, the Euro, and the British pound have all been pummeled to the downside. Now that 55% of the Scotts have voted to stay in the UK, it is likely we will see a bounce in some European currencies, and a correction in the US Dollar. Since September 8, the British pound has risen from 161 to 164 apparently anticipating the Scottish vote. The US Dollar is over extended on a short term basis and could certainly correct. Oil priced in dollars might bounce to the upside for the duration of a Dollar correction.
Meanwhile the US stock market is still on a tear. It looks like the NASD is poised to re-visit its March 2000 high at 5,000. My hesitation on stocks is simply that the wild ride up can reverse in similar fashion. It has been several years since we had even a 10% correction in the stock market . But for now the ever-reliable New York Stock Exchange Advance Decline line is still headed up.
Dennis Elam PhD CPA blogs on markets at http://www.themarketpersepctive.com
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