The COT is totally useless as an indication of anything and has been for some time for most commodities.
i disagree. maybe the COTs won't help you trade every squiggle, but large directional changes in the CL COTs correlate well with large directional changes in price. there is considerable correlation between large moves in the COTs and energy indexes as well. for example, when the commercials in the COTs breach a new 52-week high in their short position, look out below! (that has not happened yet, btw.) so the COTs are not what i would call "totally useless".
You'd know that if you actually traded crude or any other commodity in any size.
there are 951K CL contracts open. that represents an amount of oil 30% larger than the US Strategic Petroleum Reserve, and works out to about $64 billion in dollar value. that is a significant sum of money to everybody but maybe the people running the US govt -g-.
in fact i do have some experience buying crude. i was buying in spring of 2004, when the 5 and 6yr contracts were in steep backwardation. i was able to accumulate these in lots of 5 or 10 a day around 27 without moving the price, while spot was 36 or 40 or so. certainly the 5 and 6yr markets are illiquid for large or even small speculators seeking to daytrade, but i don't think that's where the action is anyway. the brokers i placed my orders with didn't even know the symbols for 5 and 6yr trades and they weren't in the electronic system and had to be manually entered. so nobody, basically, was interested in these trades. while i have no way to verify, i really doubt the action in OTC is focused on 5 and 6yr crude, with the exception of producers looking to hedge.
other than a producer, who is going to take the short side of that 6yr trade at a discount to spot? how is the counterparty going to hedge their short when they are selling the cheapest contract on the strip, with the most time till expiration? they had better hope for a global depression and bird flu, and hope doesn't count as a delta hedge.
in a strictly fwiw comment, i think OTC action would also be heavily weighted toward the next three years, with the exception of hedging producers who are selling at a discount to spot. obviously, producers are not going to hedge more than they plan to produce (and increasingly, are not hedging ANYTHING above the minimums required by their loan covenants), so this (commercial hedging of long-dated futures) figure in volume terms and dollar amounts is likely just a tiny fraction of $900 billion.
back to the NYMEX. i must admit that my lowly account is nowhere near $64 billion in size. but somehow, it strikes me that $64 billion is a considerable sum of money and, since there are precise figures as to the net short and long positions of traders, not something i would call "totally useless".
if you can provide the precise figures of net short/long positions of traders in the OTC market, i will be very interested to see them. as i understand it, the OTC positions are not reported, except in gross numbers, so there's no way for outsiders to tell who is net short/long what.
What I have said is that there is probably a $10 or so premium (sometimes larger) in oil due to "investment" demand
a $10 premium due to investment demand. that's amazingly similar to the $10 premium (sometimes larger) in oil due to "Iran & Co." envisioned in the latest Barron's:
"Fears about potential supply disruptions in Nigeria and Iran added as much as $10 to oil prices in recent days, says Fadel Gheit, a senior energy analyst at Oppenheimer & Co., the independent brokerage in New York."
and from today's Bloomberg: "`It's geopolitical risk that's sustaining the market at these prices,' said Tetsu Emori, strategist at Mitsui Bussan Futures Ltd. in Tokyo. `As long as the Iran issue is unresolved it hard for traders to sell.'"
so how do you know it is due to your "investors" and not Gheit's "Iran", or Emori's "geopolitical risk"?
how do you know it is not due to greedy oil companies witholding supply to drive up prices as Barbara Boxer has claimed, or due to the fact that oil producers, after having lost billions on hedging programs in 2004, have drastically reduced their hedging programs (and hence the heavy forward selling pressure)? how do you know it is not due to record low spare production capacity?
how do you know it is $10, which is remarkably similar to the $10 premium that was supposedly in crude according to Lee Raymond, CEO of Exxon, and also according to the Saudi Oil Minister Ali al-Naimi and Prince Bandar "Bush" (who supposedly promised $28 crude by August 04 so Bush would be reelected), when CL was at $40 (and they were all predicting a return to the $20s), well before your $900 billion inflow of 2005?
if this speculative demand is really padding crude prices to such an extent, why don't all the producers just sell out their production for the next 6 years and lock in prices over $65 a barrel on average? then their stock prices would rise 50% because they are currently discounting $40-45. (in fact, some have voiced fears that private equity investors could do LBOs of some public cos and sell forward on the 6yr strip to arbitrage this mispricing.) why have so many instead stopped hedging? haven't they also talked to traders and other people and heard about this "beyond dispute" $10 premium?
it seems to me one could assign any desired premium to any purported inflationary factor. it is more a Rorschach test than anything. politicians call it a terror premium or greedy oil company premium; bearish energy analysts who have been wrong on CL for six years running call it speculative demand; oil execs who fear windfall profit taxes or who foolishly put in massive long-term hedges at much lower prices or do not stand to benefit from further CL upside due to the stipulations of their concessions in the ME blame speculators and terrorists and the Saudis and the environmentalists. so maybe it's an "environmentalist premium". or a "Chavez premium", or an "Iran premium".
those are hardly the only explanations. another one is that after a couple years of rising crude prices, oil companies got tired of losing billions in hedges and stopped shorting crude. that cuts a lot of sell weight off the forward strip. as i understand it, that is the explanation proposed by Don Coxe for the development of contango on the near months and years.
you can say there's $5 of terror premium, $5 of "investor" premium, $5 of "nobody's hedging" premium, $5 of low-capacity premium, and so on. it is all just guesses. the fact remains that crude sells at what it sells at, despite a lack of speculator fervor in some $64 billion of known trader positions. if somebody wants to GUESS as to the trader positioning in UNKNOWN positions in OTC transactions, and as to the precise magnitude of their impact on CL, well, that is OK but i just don't buy into that logic.
This premium is beyond dispute. Everyone from oil execs to analysts know it's there.
beyond dispute? personally, i think the major oil execs never state anything without considering the political ramifications of their statement. you'd think Lee Raymond would be pretty knowledgeable, and yet he has been consistently bearish on crude in public for many years. he thought $35 wouldn't last, then $40, then $45, then $50. as CEO of Exxon, he obviously has had great information, as these things go; how could he be so wrong? maybe he didn't really say what he thinks?
all these "oil execs" and "analysts" may "know it's there", but they have been incredibly unreliable in predicting future crude prices for six years running.
I rely on others much more knowledgeable about the subject than me.
the world of oil is like the story of blind men touching one part of the elephant or another. one says the elephant is a trunk, another says it's a tail, a third says it's a big foot. Lee Raymond is as close to a one-eyed guy in the kingdom of the blind as you're going to get, and he's been plumb wrong for years. do your contacts know more than he does?
really and truly, this speculative demand may be there in spades in the OTC despite any indication of such in the COTs, but what if Matt Simmons is right and Saudi production is about to keel over to the tune of 5% a year? the world is not ready for that scenario, and $65 crude is not discounting it. there are just so many potential scenarios that could develop it is anybody's guess as to what price discounts the most likely eventuality. Simmons thinks crude should be $160 or something crazy, and maybe he's right. at least that would get people to conserve and stop living in LaLa-land.
Do you really think that $900 billion can flow into commodity derivatives in the first 9 months of 2005 alone and not affect the prices of commodity markets??? Don't be naive.
i never said there is no speculative element to energy prices. given that CL has more than sextupled off its lows, it would be surprising if there were no speculators. i just say this element is not quantifiable, as a discrete element (like "$10 premium"), distinct from all the other gazillion things that affect energy prices.
as for $900 billion into commodity derivatives, if oil has been dotcommed, why wouldn't it affect retail investors? retail investors don't have direct access to OTC, so wouldn't they be buying up the futures like there was no tomorrow? they certainly bought up all the dotcoms back in the day! that sure is a stealthy dotcom in crude, since small specs have been net short through its entire duration. wouldn't retail investors be bidding the oil companies up to PEs over 6, or 8, or 10? why don't they all trade at 30 or 50 or 100x PEs like the dotcoms did? why is energy only 10% of the SPX instead of 30% of it like in 1980, when it was the true dotcom of the day?
lastly, a comment about contango. some have said the crude contango in the near months and years is evidence of extreme speculation. however, the back three years of crude are actually in backwardation. this is not a contango at all.
however, there has been a marked change from complete or near-complete backwardation (including very steep backwardation on the 12-month strip in 2004) in CL, toward a modest contango. if you want to see a steep contango, take a look at gold. December 2010 gold closed Friday at 713, vs. 569 for this March. by contrast, December 2010 crude closed Friday at 64.71, vs. 65.37 for this March. which commodity has a big contango?
some very unusual things have happened to crude in the last few years. producers have cut down hedging. OPEC has lost all credibility in terms of being able to bring on excess swing supply. crude has gone much higher for much longer than anybody thought possible. major oil companies like Shell and Repsol have had to drastically mark down their reserves, while even the biggest (Exxon, BP) have experienced YoY declines in boe production despite the best price incentives to produce in a generation. the backwardation on the 12-month strip has disappeared as producer CFOs took multibillion-dollar hits on their 04/05 hedges. maybe, just maybe, it is a recognition of a paradigm shift in crude prices. Jeremy Grantham comments on this in the latest Barron's:
Q: How is oil affecting your view?
A: Going back a hundred years, with inflation taken out, you can see how beautifully oil reverts to the mean. For around 100 years, the mean price was $16 a barrel in today's dollars. Now we're seeing a paradigm shift, the first of my career. Indeed, it's the first and only paradigm shift that we can see in an important asset class ever.
Q: Are you in the camp that oil goes to triple digits?
A: This is my problem. If our exhibit is to be believed, and I think it is believable, oil prices have shifted into a new range. It wouldn't amaze me at all that the new trend was $45, in which case you could expect the price to drop to $25, or you could also expect it to go to $100.
If the new range is around $45 a barrel, it can spend a lot of time in the 70s, and that would be no big deal. It can still break down to $25 a barrel, and that would be perfectly consistent with a new higher level. What it is unlikely to do is what it did in 1999, and that is go back to $10 or $12, or $13 to $15 in today's currency. Oil has clearly broken out of its old 100-year range, and it is going to stay broken out and probably trade on average higher. It is not a particularly good short sale even at current prices.
so Grantham, a man whose words are worth heeding, sees the first paradigm shift of his career in crude pricing. specs can come on and off the boat. obviously at $65 they may be more inclined to board, and the boat will be full at $100. but at $25 they will all be flushed out again. even Grantham is guessing that $45 is the new long-term median price. all we have is a straight-up shot from $11 a few years back. maybe the new equilibrium will be $75. personally, i think it will be a price that causes demand destruction, because supply is not responding. if oil production has indeed peaked here at around 84-85mmbpd then all bets are off.
btw, the existence of the modest contango in CL changes the economics of inventories. permabears on crude like Andy Xie love to point to crude inventory buildup as a sign of an impending crash and glut. and yet the price keeps going up. well, maybe the inventories are up because with contango, people get paid to hold inventory whereas in backwardation they are losing money. or, a buyer needing crude in December with spare storage capacity now could take delivery now instead of locking in December's higher price. backwardation is a disincentive to inventorize. a contango is another marginal factor leading to increased inventories. therefore, comparing inventories in contango vs. inventories in backwardation is comparing apples and oranges. |
