Forward Curve Showing Higher Prices?

Saturday, October 10, 2009

"The steepest plunge in crude prices on record may be setting up oil investors for a rally this year, if history is any guide. The so-called forward curve of futures contracts traded on the New York Mercantile Exchange suggests oil will rise 28 percent to $60.10 a barrel by December. The curve looks almost the same as 10 years ago, after Russia’s default and the collapse of the Long-Term Capital Management LP hedge fund raised concerns that a global economic slowdown would reduce energy demand. Crude prices fell 25 percent in the final quarter of 1998, the steepest drop in seven years. Bets on a recovery paid off then as the Organization of Petroleum Exporting Countries cut production 6.9 percent, causing prices to more than double in 1999." in Bloomberg

The problem with this step forward curve in crude oil futures prices is that you have to pay contango to hold your speculative oil position. Crude for February delivery traded at 46.89 a barrel compared with 60.10 for the December 2009 contract. A similar thing occurred at the end of December 1998, oil for February 1999 was at 12.05 (that was a bargain!), compared with 13.78 for December of that year, a difference of 14 percent.

The magic thing about contango is that if you are bearish on oil prices you can short oil and get paid big time even if crude oil doesn`t not drop in price.


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