Why is OPEC expecting a sharp drop in oil prices? First, much of the rise in oil prices has followed the rally on Wall Street. Investors reasoned that higher stock prices means that business is doing better and hence a need for more oil, and prices rise.
Not so fast. Business demand for oil is weak, and the consumer got clobbered by the recession and is holding back spending money. So the classic relationship between the stock market and oil that investors follow is not there this year.
The Wall Street Journal is reporting that stockpiles are at a 24-year high. Distillate demand for gasoline and diesel fuel dropped by 15%. Refiners have cut back production to 85.8%, from 87.9% the previous week. Distillate stocks surged to 160.5 million barrels, the highest level since 1985.
The price of September crude closed at $68.05 per barrel on Friday, up 89 cents. The futures contracts for crude in are a contango. What is a contango? It is a futures market where the prices for distant contracts are higher that those for nearby delivery. For example, the September futures contract closed at $68.05 per barrel while the December contract closed at $72.52 per barrel. This sets up a huge profit margin for oil traders. They simply buy the cash crude oil and sell distant futures contracts against them. The profit spread between September and December is $4.47 per barrel. Figure that profit on say 1,000,000 barrels.
The effect of these factors are that the buyers of nearby oil have no more room to store it. They are using tankers and barges and running out of room. So now we have a glut of oil. OPEC sees this and is bracing for a sharp drop in prices.
This is also how banks are racking up huge profits. They are borrowing money at 0.25% from the Fed and lending it out longer term at much higher rates to businesses and consumers.
Would you sell oil contracts at these levels?
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Reader Comments (Page 1 of 1)
7-25-2009 @ 6:16PM
Michael R. said...
It is ridiculous to think OPEC won't cut production again.
They will shore it up one way or another if oil starts looking 50ish again. Solution: move to natural gas and bring tons of new jobs to america while relying on our own commodities for energy.
It's a REAL BIG DUH! that no one seems to get, especially in the long run.
7-25-2009 @ 7:26PM
ij70 said...
Michael R. have you ever wondered how to bring jobs to America? The only ways that I can figure out are:
1) weaken dollar so that we can sell our products cheaper then some of the competition
2) put tariffs on imports so that it would be more profitable to manufacture things here and less profitable to import them from over there
Now ask yourself this question: Why the past three administrations have not done any of these things?
7-26-2009 @ 12:33AM
Tech said...
Saudi Arabia backs the US dollar by only selling it's sour crude for our paper. We protect their corrupt regime with our military. Now as the banksters have fleeced us so badly and had to bail themselves etc. out with trillions! what is keeping the dollar from collapsing? Our military in the oil fields and everyone having to buy oil on the global markets with US dollars! Even so people are scared as there's no other economic backing for the dollar now. Our non-economy is so debt ridden and broke and we have unemployment almost as high as during the last Great Depression. Good time to drop the oil price which boosts the dollar and they can fleece all the suckers who piled into the stock market one last time. Oil and stocks track so this WILL mean stocks will drop again! Use trends, use stops, and be careful and you won't lose up or down. Listening to any "expert" and you could lose a lot. Charts and trendlines tell the truth.
7-26-2009 @ 7:31AM
Jasper Reijdink said...
Since crude oil is priced in USD, there is always the possibility that a changing oil price does not reflect a change of oil's value, but rather a change to the USD's value. When the USD lost value around 1970 because of inflation, the end of the Bretton Woods monetary system and the abandonment of gold coverage, it ended the slow decline of the oil price that had lasted for decades.
If the U.S. economy does not get back on track, the U.S. trade deficit as well as debt are going to increase and there will not be enough goods and services to match the growth of money supply. This would probably lead to a devaluation of the USD and therefore a rising oil price - as long as it IS priced in USD - even if the value of oil remains unchanged.