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Guest Post: Peter Beutel On The Relevance Of Crude Oil Futures

Submitted by Tyler Durden on 05/14/2010 15:17 -0400

Guest Post By Peter Beutel of Cameron Hanover, courtesy of FMXConnect.com

After reading a Zero Hedge article on crude oil futures earlier
today I was motivated to write something on the topic. I have been
railing against the securitization of the oil futures market for some
time. It’s nice to see someone else sharing those sentiments. Below are
some notes I jotted down after reading the article.

I
do have to agree that for 14-15 months, almost without interruption
now, and since August, 2007, more generally, that the Nymex crude oil
contract has too often been used as a surrogate for the economy, the
DJIA or currencies, most notably the euro. However, last week’s sharp
decline may have severed the relationships, at least temporarily.

This
misbegotten adventure as a surrogate started a decade ago, when a
little-known scholarly piece, 15 or 20 years old by then, came into
vogue with at least one large investment bank on Wall Street. This
piece had been suggesting a 10% commodities exposure as part of any
balanced portfolio. For years, this recommendation had been a
professorial urging and little more. But, by the late summer of 2007,
not only had this investment bank embraced the philosophy, it had won
over converts among union pension funds, sovereign wealth
agglomerations and – this one should not surprise anyone – university
foundations. When Ben Bernanke spoke of his “new transparency” in
August, 2007, and then telegraphed lenient (or artificially low)
interest rates for the foreseeable future, crude oil prices burst over
a potential double top at $78.40 (July, 2006) and $78.77 (August, 2007)
and started on its record run to $147 a barrel over the next 11 months.

Prior
to this new “10%” philosophy, large moneyed interests had purchased
shares of integrated oil refiners with oil in the ground rather than
oil futures, or ADM or Cargill instead of grain futures. By buying the
outright commodities, these customers of the large investment bank
pushed up the prices on basic food and fuel commodities, which
ultimately forced consumers to choose between getting to work and
eating or paying mortgages on time. The end result was the existing
recession. The large investment bank had effectively tried to make
money on mortgages and on higher commodities prices. It was like trying
to sheer the sheep it had eaten the night before as mutton. The
government ended up needing to bail out this same bank.

Between
the big collapse in oil prices over the second half of 2008 and again
last week, the early results suggest that investors may have finally
figured out what a poor investment oil really is. The investors who got
out of oil last week were not getting back in this week. They seem to
have bought back equities, but they seem to have decided that gold is
the real play from here. With any luck, they will buy shares of
integrated oil companies and leave oil futures alone. It will end up
better for everyone.

Curiously enough, the recent blow-out in
the contango may actually be making WTI, or Light Sweet crude relevant
again. We may need a wide contango to help us get the crude oil
contract back as the vibrant, dynamic hedge instrument it was for
nearly a quarter of a century before being taken on as an “investment.”
I agree that it has not been that since March, 2009 and possibly back
to August, 2007. Nonetheless, I remember its best days, when refiners
and producers used it regularly, in the days when it really was a
hedge. If we can just get the “demon” out of it, exorcized, there is no
reason to throw out the baby with the bath water. Position limits will
help, but time itself seems to be working in its favor. Crude oil
futures were designed as a hedge and not as an investment. Last week
seems to have hammered that point home to investors now buying gold,
instead.

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Fri, 05/14/2010 - 15:33 | 352472 Sudden Debt

That BP engineer saying "we don't need to worry about enough oil and gas, the question rather is if we have enough air to burn it!" might have put some people to the thinking act.

Peak oil my ass!

Fri, 05/14/2010 - 16:03 | 352545 moneymutt

I guess I would rather have expensive gold rather than oil, don't buy much jewelry but sure do need to drive and heat my house.

How do we get the "devil" out of commodity trading without overly interfering? I get people need hedges but when big money sloshes from one commodity to the next inflating speculative bubbles, as you describe, regular folks and regular businesses suffer.

Part of the issue with too much speculation in basic commodities, I think, is too sudden changes are wasteful for economy. We already incur enough unavoidable disruptions due natural disasters, wars, strikes etc..why add to the mess by whip sawing the price of the basics for no fundamental reason. Whole economy gets structured around a certain price of oil (like centralizing manufacturing and transporting things far when decentralized might be better when gas prices high) and then, voila, for no reason other than casino players rolling the dice, our whole system is horribly inefficient...GM starts banging out Aveos and then, no one to buy cause gas is $1.50 gallon.

How do we minimize this mess...

Fri, 05/14/2010 - 16:09 | 352569 Sudden Debt

You should. Nothing gets the misses faster on her hands and knees then a nice ring, and if you add a rock to that she becomes a carousel ;)

Fri, 05/14/2010 - 16:27 | 352613 moneymutt

depends on what type of misses you have...

Fri, 05/14/2010 - 17:14 | 352718 Dirtt

Avoid diamonds. Buy emeralds. And I'd keep the ring in the safe otherwise your sweetie might get her finger cut off.

Crime is accelerating.

Sat, 05/15/2010 - 02:29 | 353352 Grand Supercycle

The March 2009 bear market rally ended last week.

http://tinyurl.com/39ptoac

http://www.zerohedge.com/forum/latest-market-outlook-1

Sat, 05/15/2010 - 08:15 | 353476 dcb

if you purchase dbc you have varied long commodity exposure with long dated futures so aren't paying for the turn over costs asscoiated with funs that turn over every month. the big boys (and they designed the fund this way) fron run the roll over days so you pay more for the contract. then the big boys dump the holdings. this almost always works out for ung I know so if you are in these funds always know what contract they are in and the roll over days.

Sat, 06/26/2010 - 05:16 | 435034 mbtshoe

Fri, 10/15/2010 - 03:07 | 652058 nikejordan

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Guest Post: Peter Beutel On The Relevance Of Crude Oil Futures

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