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Oil Prices: What the Futures Market Sees
It may be a better indicator of upcoming prices, says a government study. The verdict now? Petroleum is headed higher
by Peter Coy
Thirsting for an Accuracy
Crude price moves created big winners and losers in Corporate America in 2006. Exxon Mobil (XOM) announced on Feb. 1 that it earned $39.5 billion in profits last year. That was the most profit of any company ever, even though the late-year dip in crude caused profits to fall in the fourth quarter. Royal Dutch Shell (RDS) reported a $25.6 billion annual profit. On the other hand, high oil prices hurt the popularity of sport-utility vehicles and pickup trucks, creaming companies like Ford Motor (FLink to Oil Swaps Market
But the futures market has matured since 2000, the number of open long-term contracts has shot up, and the prices of long-dated futures are being viewed by market participants as a more reliable indicator of where oil prices are headed, says the CFTC study, authored by Michael Haigh, associate chief economist; Jeffrey Harris, consulting economist; Overdahl; and Michel Robe, consulting economist.
So, what is the futures market saying? On Feb. 1, Nymex prices settled at $57 for delivery in March '07; $63 in March '08; and about $62 for succeeding months out until the end of 2012. Even now, trading is thin to nonexistent in many of the further-out contracts, but there's a bulge of activity in the longest-dated contract, Dec. 12.
The New York Mercantile Exchange is far from the only place where long-term oil-price agreements are made. In fact, Nymex volumes seem to be growing largely because of the exchange's link to the huge oil swaps market. This global market is not an exchange, but an over-the-counter market operated by some of the world's biggest banks. In a typical swap, one party locks in a fixed price for oil at a future date and the counterparty agrees to pay (or receive) whatever the fluctuating market price is on that date.
Useful Long-Term Predictions
According to the CFTC study, the biggest increase in long-term positions outstanding on Nymex has been by dealers in oil swaps, who presumably are using futures contracts to hedge their risks from swap deals. Their positions outstanding grew 481% from 2000 to a 2006 average of 14,600 contracts, according to the CFTC. Hedge funds' positions outstanding grew 999% over the same period to an average of 11,200 contracts. Each contract is for 1,000 barrels, so 14,600 contracts represent over $800 million worth of oil. Together, hedge funds and swap dealers accounted for over 40% of positions outstanding last year in long-dated futures, the CFTC study revealed.
Since the futures and swap markets are linked, it's no surprise that prices in the swap market reflect the same price expectations. According to Bloomberg Financial Markets, which surveys dealers for their prices, on Feb. 1 West Texas Intermediate oil was trading at $61 or $62 in the swaps market for 2008 through 2011.
People outside the CFTC are encouraged by the maturation of the long-dated oil futures market, though cautious. Jan Stuart, the oil economist for the equity research arm of the investment bank UBS (UBS), says the Nymex is "beginning to emerge" as a source of useful long-term price predictions. If that continues, "that would be terrifically valuable to me," he said.
Philip K. Verleger Jr., an energy economist who runs PKVerleger in Aspen, Colo., said he remains somewhat skeptical about the predictive value of Nymex futures. He puts more weight in another market indicator: the New York Stock Exchange-traded BP Prudhoe Bay Royalty Trust (BPT), which was set up in 1989. Its royalty-payment structure makes it a pure play for investors on the direction of the oil market. As it turns out, though, the BP trust is flashing similar signals. Verleger says the current price implies an expectation of oil prices rising 3% a year from current levels.
True, the futures and swaps markets are hardly perfect predictors of oil prices. After all, long-term futures prices have gyrated almost as much as spot prices in the past year, indicating massive uncertainty. But the collective wisdom of the market is about the best forecast you can hope for. That's why the deepening of long-term markets is good news, no matter which way the price indicator points.
Coy is BusinessWeek's Economics Editor.
It may be a better indicator of upcoming prices, says a government study. The verdict now? Petroleum is headed higher
by Peter Coy
Thirsting for an Accuracy
Crude price moves created big winners and losers in Corporate America in 2006. Exxon Mobil (XOM) announced on Feb. 1 that it earned $39.5 billion in profits last year. That was the most profit of any company ever, even though the late-year dip in crude caused profits to fall in the fourth quarter. Royal Dutch Shell (RDS) reported a $25.6 billion annual profit. On the other hand, high oil prices hurt the popularity of sport-utility vehicles and pickup trucks, creaming companies like Ford Motor (FLink to Oil Swaps Market
But the futures market has matured since 2000, the number of open long-term contracts has shot up, and the prices of long-dated futures are being viewed by market participants as a more reliable indicator of where oil prices are headed, says the CFTC study, authored by Michael Haigh, associate chief economist; Jeffrey Harris, consulting economist; Overdahl; and Michel Robe, consulting economist.
So, what is the futures market saying? On Feb. 1, Nymex prices settled at $57 for delivery in March '07; $63 in March '08; and about $62 for succeeding months out until the end of 2012. Even now, trading is thin to nonexistent in many of the further-out contracts, but there's a bulge of activity in the longest-dated contract, Dec. 12.
The New York Mercantile Exchange is far from the only place where long-term oil-price agreements are made. In fact, Nymex volumes seem to be growing largely because of the exchange's link to the huge oil swaps market. This global market is not an exchange, but an over-the-counter market operated by some of the world's biggest banks. In a typical swap, one party locks in a fixed price for oil at a future date and the counterparty agrees to pay (or receive) whatever the fluctuating market price is on that date.
Useful Long-Term Predictions
According to the CFTC study, the biggest increase in long-term positions outstanding on Nymex has been by dealers in oil swaps, who presumably are using futures contracts to hedge their risks from swap deals. Their positions outstanding grew 481% from 2000 to a 2006 average of 14,600 contracts, according to the CFTC. Hedge funds' positions outstanding grew 999% over the same period to an average of 11,200 contracts. Each contract is for 1,000 barrels, so 14,600 contracts represent over $800 million worth of oil. Together, hedge funds and swap dealers accounted for over 40% of positions outstanding last year in long-dated futures, the CFTC study revealed.
Since the futures and swap markets are linked, it's no surprise that prices in the swap market reflect the same price expectations. According to Bloomberg Financial Markets, which surveys dealers for their prices, on Feb. 1 West Texas Intermediate oil was trading at $61 or $62 in the swaps market for 2008 through 2011.
People outside the CFTC are encouraged by the maturation of the long-dated oil futures market, though cautious. Jan Stuart, the oil economist for the equity research arm of the investment bank UBS (UBS), says the Nymex is "beginning to emerge" as a source of useful long-term price predictions. If that continues, "that would be terrifically valuable to me," he said.
Philip K. Verleger Jr., an energy economist who runs PKVerleger in Aspen, Colo., said he remains somewhat skeptical about the predictive value of Nymex futures. He puts more weight in another market indicator: the New York Stock Exchange-traded BP Prudhoe Bay Royalty Trust (BPT), which was set up in 1989. Its royalty-payment structure makes it a pure play for investors on the direction of the oil market. As it turns out, though, the BP trust is flashing similar signals. Verleger says the current price implies an expectation of oil prices rising 3% a year from current levels.
True, the futures and swaps markets are hardly perfect predictors of oil prices. After all, long-term futures prices have gyrated almost as much as spot prices in the past year, indicating massive uncertainty. But the collective wisdom of the market is about the best forecast you can hope for. That's why the deepening of long-term markets is good news, no matter which way the price indicator points.
Coy is BusinessWeek's Economics Editor.
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