Something very unusual is happening in the oil markets... and it’ll keep the oil price way above $100 for the rest of year.
The WTI futures market is now in "contango" - a highly extraordinary situation.
And it’s yet another bullish sign for the oil price. I’ll tell you how to best profit from this in just a moment.
First though, what is contango? I’ll explain...
It is where the price of a commodity for future delivery is higher than the spot price - i.e. how much it’s trading for at this precise moment in time.
What normally happens is the opposite. Longer-term futures are usually lower than near-term.
This tells us one crucial thing: that fears for future supply are high.
You see, major oil companies don’t use the latest futures contracts to plan their budgets... they use the futures strip price which is the average value of the next 12 contracts.
And right now, that’s more than what oil trading for.
What’s also unprecedented is the speed with which this change in the curve has happened.
The WTI contract for delivery in December 2016 has surged $17.08 (a staggering 14%) in just three trading days. Not only that, crude for delivery in July this year rose just 1.9% over the same three-day period.
So, what’s going on..?
This price action in the derivative markets could mean one of three things:
- The market expects near-term demand to slump.
- Fuel-reliant businesses such as airlines, cruise operators and logistics companies are hedging against significant price rises.
- The market expects future oil supply will not meet future oil demand.
Now, nothing in this world is caused by just one event, a combination of factors entwine to cause a reaction. However, I think we can discount a near-term slump in oil consumption as the reason for the curve shift.
All the headlines in the US are about how high fuel prices are affecting people’s lives.
But with most of the developing world subsidising their fuel, WTI price rises do not affect demand in these countries. It just puts more strain on their treasury departments.
Take the recent demand figures from China...
The country’s consumption hit a record high in the first quarter of this year. The China Petroleum and Chemical Industry Association said consumption of gasoline, diesel and kerosene rose by 16.5% year-on-year in the first three months of 2008. Crude oil consumption rose by 8%.
This scenario is being repeated all across Asia.
Demand for oil is 2 million barrels higher than current supply
The second point, about hedging, is very pertinent indeed.
I believe that the Goldman Sachs forecast that oil would hit $141 in the second half of the year must have caused finance directors at all the major airlines to turn a whiter shade of pale. This, I reckon, is the cause of a significant amount of the gains.
However, I think the most important reason is concerns about future supplies.
When T. Boone Pickens parroted Goldman’s view on Tuesday (he said oil would hit $150 in the second half) he said it was because supply wasn’t keeping up with demand.
Opec expects demand this year to be 87m barrels per day (bpd). The world is only pumping 85m bpd - leaving an expected deficit of 2m bpd.
The combination of Goldman’s warnings with Pickens comments has sent the futures market higher. This has made its way into spot prices (which hit a record just below $130 yesterday).
These type of comments are almost becoming self-fulfilling prophesies. Goldman (which has been best at calling the oil spike) says something will happen so futures are dragged higher. This pulls up the spot price.
Great news for one under-valued oil play...
These events are manna from heaven for our Smart Commodities UK oil play.
If analysts other than Goldman don’t raise their oil-price forecasts, then it is almost certain that it will beat consensus expectations in the next quarter and its shares will be re-rated.
If other brokers do actually raise their expectations, then the whole sector will need to be re-rated because the forward price-earnings multiple would fall to a ridiculous level.
Even after recent gains, my recommendation is trading on a price-earnings multiple of around 8.
This is an utterly ridiculous rating for a company selling a vital product in a contango market.
If you’d like to access this company’s details, you can do so here.
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Regards,
Garry White
Editor
Smart Commodities UK
