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The Oil-Gas Six Sigma Dislocation
The CFTC has earned its stripes by allowing speculators to take the oil to natty relationship to unprecedented arb levels. Represented in energy content equivalents, where oil traditionally has been in the 6x-12x range for gas, the most recent reading is 26.36! This is, as the chart indicates, your six sigma event for the day.
A long NG1 - short CL1 arb may take some abuse but absent Amaranth coming out of somewhere (and even they were eventually prosecuted), this relationship should collapse to some semblance of normalcy. Although in this bizarro market it is guaranteed to do the opposite of what any fundamental or technical relationships dictate.
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Congress even just approved $300M in Cash for Gas (Nat) to try to break this; I'm pretty sure it ended up going to Brazilian oil drilling, and was swapped from Dollars to Real today...
http://www.energy.gov/news2009/7843.htm
Today is the NGU9 contract expiration. The current oil/gas is 22.8 already.
You are making it more complicated that it is. Oil is now seen as a store of value, an alternative to the USD. NatGas, not having the same worldwide demand, is not.
You realize that this crap though, right? Eventually somebody's gonna have to use that oil. If they don't it's value is less than zero. What you said is the same thing that sent oil to its all time high, with great damage to this economy and consumer's pocketbooks.
You realize it's "value", as you call it, is priced in USD? Sure, someone is going to have to use it at sometime - that is its true "value". But its "price" is measured in something that many expect to depreciate rapidly.
You view everything through the lens of the USD. Don't.
To my point, here are the latest stats on MBS purchases for the Fed, $25.4B in the past week.
http://www.ny.frb.org/markets/mbs/index.html
(And where is that asshole who claimed on these boards that purchases were slowing down?)
That is $25B more of newly printed dollars to compete with the dollars that you have in your bank account.
So is the price of oil being driven by the denominator, or the numerator?
Yeah....Oil is the new GOLD!
Whatever happened to all those full oil tankers waiting for oil to go above 80? Maybe they're trying to drive up the price.
Also you can't put nat gas in your tractor, some demand is inelastic this time of year.
Everyone discounts the A variable here. When A is the change in technology (therefore efficiency) then supply and demand are no longer singularly correlated at 1. The previously conceived impossibility evolves into actuality and the black swan event occurs. A is based on unforeseeable black swan events and not simply the fact that peak oil is currently occurring.
Tyler it has already collapsed, just in the future future months. Take Dec 10 Futures ratio for example. Nowhere near as extreme. There is a slim probability that we may see a 9 signma event ( is there such a thing?) with NG futures going to zero for October. Unless they shut production fast enough and there are no signs that they are where exactly are you going to put the NG you purchase? Storage is full and in another month things are going to look positively bursting.
How many six sigma events have "happened" in the various markets over the past 12 months?
Is this cluster of six sigma events itself a six sigma event?
More importantly, when will the rate of six-sigma cluster growth begin slowing, the second derivative measure indicating mean reversion green shoots?
No it won't. 6:1-12:1 is dead for the forseeable future.
Gas is the only commodity that is local and trades supply and demand because of storage constraints. Crude on the other hand has become a separate asset class and thus subject to huge institutional (GS propr desk) investment inflows, those inflows have changed the structure of the crude market.
The next move on natty is going to be the flattening of the curve.
You shut it in.
It is. But there is no choice. Once storage is full only one place for natty, the ground. Here, new production is not being tied-in and the smarter producers have already started shutting in production.
The problem is you yanks (referring to u.s producers). So far most of the producers have refused to shut in production and it ain't because it is hard to do. It is because the only way the can make their numbers is through volume. And they have to maker their numbers in order for their stock price to increase. And that is the way the CEO's get bonuses. So in Q2 all the majors pumped more of an increasingly unprofitable product into a supply glut.
As an example of the new economics, on the Anadarko call (aug 3) they said that in response to lower prices they are cutting cost (firing people) rather than slowing production. So all good, as long as the CEO makes his bonus.
In the absence of really hot weather where you are, or a hurricane, or really cold weather on Oct 1 it is going to be a shit show.
Concur totally. We're also still seeing new production hitting the market as wells in the new shale plays, that were drilled last year when prices were triple or quadruple what they are now, come online.
Quoting one of the heads of the regional storage companies: "It's gonna take more than a single hurricane... more like 3 or 4."
NG priced in DXY reflects the glut caused in part by lack of demand by utilities, factories etc. Crude and not gold is the new DXY hedge and so the spread between the two is only going to get wider as the economy tips over and the dollar keeps sliding.
True except one detail: it isn't that new. As soon as America left the gold standard in the 70s, we've been running on an implicit oil standard for our currency. It's just more obvious now.
This means that crude is pricing on good fundamentals, and that natural gas is due to just go zooming to the empyrean heights, right?
NG price is very much location and local storage capacity dependent. Oil is not. Nat Gas in Europe trades at totally different prices. But US can't export to Europe (no appropriate terminals)...
"unprecedented arb levels"? What's the arbitrage? You think that because two things historically traded in a range together they have to stay in that range? You should ask *why* they traded in that range, and what is different today.
only clowns are sitting at the trading desks in the last week of August.
just wait for September, it's gonna be ugly
70% of US crude is used by transportation. Much of it is imported.
Natural gas is used residentially, comercially, industrially, and for electricity. Technically 100% domestic (though geography means it's exported to Mex and Can in some places and imported in others.)
And David Patterson wants to frack the shit out of New York.
There is a whole lot of front-end engineering work being performed right now for converting boiler operations to flexible input of either bunker oil or natural gas. Anyone in the US who can get a lateral into a distribution system is having someone do a bunch of calculations and conceptual drawings for them.
TD, yep, wouldn't recommend you call this one eighter. Fed, dollar, oil won't allow this to be where it should be. (or ABK, AIG, C, ect)
Or, AIG secretly manufacturing Nat gas vehicles...shhhh, don't tell anyone
TD,
6:1 and 12:1 are purely arbitrary numbers, talked more about in the context of heat conversion as opposed to price.
American storage is at all time highs because the production of unconventional, shale gas is cheaper than ever before. There is no "fundamental" relationship between gas and oil, and no reason as to why the ratio should narrow.
A more important thing to analyze is the persistence of the contango curve over time. I would guess that the curve has been this sloped for longer than ever before. This, of course, is because there's no storage to arb away the slope of the curve.
There is a physical "fundamental" relationship: It's called GTL - gas-to-liquids. If there is a fundamental long term glut of NG, and a shortage of liquids, the convertion wil earn you a nice profit. You just have to secure a long term contract of cheap NG and gamble on the price of gasoline staying above a certain price.
Any ZHr's out there know how to access specific quotes on bloomberg.com (not the terminal) for commodities like NG1 in the same way I can access all manner of indices e.g.
http://www.bloomberg.com/apps/quote?ticker=DOEASCRD%3AIND
or this
http://www.bloomberg.com/apps/quote?ticker=S5FINL%3AIND
same question on FOREX
thanks
I'm not trying to be a wise-ass, but I wouldn't necessarily assume normality for a ratio of two random variables. For example, if the two variables were both standard Gaussian, then the ratio would follow a Cauchy distribution (equivalent to a t-distribution with 1 degree of freedom), an extremely fat-tailed distribution. I get your point that the divergence is extreme, but for such a distribution, that would not be unexpected. Having said that; all models are wrong, but some are useful.
I think you are overthinking this one.
The name of the game here is to highlight any two things that customarily have some correlation and find a day/week/month that they do not. Then intimate that there is something wrong with the security/market/world as a whole. For prior examples, look at commentary on the VIX. Or when stocks and bonds rise the same day. Or drop the same day. Or highlighting only days when the dollar is down and giving that as the reason for a directional move in equities.
ZH is a precisely linear world...
It's all in good fun though, and the comments section is a hoot. I could spend all day on this site.
Agreed. As I said, all models are wrong, but some are useful. My point, which I didn't state explicitly, is that by referring to "six-sigma", normality is assumed as is "ultra-extreme-ness". Regarding overthinking, what's that?;)
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TD - I like you man but this post is lame...there is a reason oil is where it is and gas is where it is...they are different commodities and a random ratio has no relevance particularly in today's market.
Oil is high on OBium...
I think the heat conversion ratio is very relevant to the long term price spread between the two commodities because if one of them persists in being much more expensive per BTU, then big users (e.g., electric utilities, heavy manufacturers, fleet owners) will make the capital investments necessary to use the cheaper fuel, shifting the demand curve and driving the prices back to their "normal" spread.
On a related note, it makes me wonder how harmful the effect of speculators has been in the energy markets over the past 18 months. The yo-yo in oil prices has resulted at times in prices less than replacement cost for many producers. At other times it has absolutely crushed the American middle class freeway commuting herd. In an unrigged market, speculators perform important price discovery functions. But I suspect that in post-modern casino capitalism (i.e., fascism U.S.-style), hot money flows from the Fed to favored market participants (i.e., GS prop desk) and the collateral damage inflicted on others is severe.
Smashmouth - right, this makes a lot of sense since you can easily use crude oil to generate electricity or as a feedstock for industrial applications and use natural gas as a transportation fuel...i am being sarcastic, you can't. They serve different markets, hence the oil-gas ratio is irrelevant.
To your point, I don't see anyone in my driveway converting my car to use NG.
I just bought a ZH t-shirt. Immediately following the purchase, my bank called. I had to take out an 8% HELOC on my mcmasion to finance the buy. Thanks uncle Ben...
I'm in the energy sector and work with some folks who jointly have 60+ years doing market monitoring in the nat gas space...the only things that will put a floor under these prices are hurricanes in the Gulf, major temperature events around the country, or massive fuel switching as base load coal plants stop running because electric demand has collapsed. The latter is starting to happen now.
But electricity demand can't be collapsing because our leaders are telling us that the economy is recovering!
But if it was collapsing, as a much higher BTU feedstock priced commodity relative to coal... natural gas prices would certainly be on the pointy-end of the stick...
Doesn't make sense... UNLESS...
The problem with coal plants is that they can't cycle the way NGCC plants can, so if the demand isn't solid, you could end up running your coal plant without being able to get a reasonable price for your power. With nat gas as cheap as it is right now and with the peak demand not being very high (at least in my region, where we're having a pretty mild summer in terms of cooling degree days) the gas plants are sliding down the generation curve and replacing the intermediate coal. That might change in a few months when China reopens all of its mines and coal prices drop though.
As for the demand due to the economic recovery, for anyone that still believes that, I have this piece of land in Florida...
Thanks for the insight PBS...
Do you think the low prices will force consolidation in the NG industry and are the players already too weak to decrease output?
Somebody is praying for cold winter!
Consolidation is already starting to happen all around the oil/gas companies, starting with the small exploration, production and service companies. In the nat gas space, I think there will be some continued consolidation over the next several months. As for decreasing their output, they really aren't going to have a choice. The number of rigs in operation has fallen by a huge percentage (I want to say around 40%, but don't quote me. Check Baker-Hughes for the actual number) and production is still up. By the time we hit the normal annual re-stocking season in the fall, the physical storage will be totally full. We're already about 20% over the 5 year average storage for this time of year, and this is usually when gas supplies get drawn down. Tomorrow I should get the weekly injection numbers which should provide some insight into whether production is ramping down enough to stave off an even bigger supply overhang.
Sorry to bother you PBS but it looks like the tropical Pacific ENSO index is still trending higher. Looks like we are going to have the effects of a moderate to possibly strong El Nino this year. That means that the continental U.S. will almost certainly experience a warmer than average winter this year.
The perfect storm is approaching.
http://www.cdc.noaa.gov/enso/enso.current.html
Please, tell me more about this land. I'm *very* interested.
North American power loads were down 8% in June, 9% in july.
West: was down 12% June, 7% in July.
Texas: up 10% in July (heat).
Southern States: down 6% June , 10% July, UP 3.5% thru 1st half of August.
North East: June&July down 15%, thru the 1st half of August up 3.3%.
These are all y/y numbers.
Thanls Lizzy36, the weather has been a critical but unknowable factor.
Thanks for the numbers. The scary thing is that when you dig into them, it's the industrial demand that is really driving down the overall load. Residential and commercial demand improved in August because the temperatures picked up a little (I'm in the northeast), but I don't recall the industrials following suit. Until they start increasing their demand, I won't believe any of these recovery stories.
The recovery (such as it might be) is also going to be important to the electric industry for other reasons. There are tens of billions of dollars worth of transmission on the table right now that are all based on the assumption of a quick V-shaped recovery and a big uptick in load. If those project start to go through, we might be spending huge amounts of money on capacity and transmission that we might not need for 5-10 years. Look out for higher utility bills.
OIL is a storage of value? WoW, just imagine how much space does it take to PHYSICALLY store a million $ worth of it. Worldwide people are getting more efficient vehicles and are driving less. Transportation contributes to 70% of oil demand. Suppliers of OIL know that the more they are going to sell at higher price, the more reserves they will have to survive the tough times within the next couple of years. And those countries went on a huge spending spree, so they will need those reserves.
You can keep drinking that cool aid and be a GS pawn till they'll cross you on the oil downside or think beyond the herd behavior and focus on the risk adjusted returns. It's your choice & be aware of its consequences.
It is a fascinating market in Oil and NG, so how did it happen?
1. OPEC reduces output, US ouput increases to cover the gap and in the process reduces pressure on USD. All are winners, OPEC gets to keep oil for a better day (instead of holding paper), US imports less and less pressure on USD (every bit helps here), and domestic producers make money by producing more and selling higher than fundamentals merit. Only the consumers are losing, but that is life for these losers:-(. Clearly this can continue a while longer, at the same pace though, no increase in Oil is likely at this point.
2. NG producers in USA sell foreward futures at 5, by the time they have to deliver they can buy the contracts at 2.8 (that's called short selling their product), in fact they are making more on futures than actual margin these days. If they ever have to deliver, they locked in high prices months in advance, no problem there for them. How long can this game go? Once Winter futures crash or we go into backwardation, the game is over, and NG will recover. It appears we have a way to go on this one too (1-2 months).
It is still a rational bet, medium term, to Long NG and Short Oil if you have the endurance.
As someone who has traded the pair (long nat/short crude) I am DAMN glad I got out when it hit 18:1, I actually made money on the trade by waiting for pull backs etc. But eventually I realised that Gas was going to break the $3 mark and likely keep going south ... while JP Morgan was happy to hire a tanker for their oil and just wait.
Similarly, a good "panic" trade would likely be to long Gold/short Silver because - as an *actual* billionaire pointed out to me recently - it's a lot easier to store ten million dollars worth of gold than it is the same amount in silver!
Sounds like a silly reason to short silver.
yeah, think of how many millions of people (non-billionaires) could afford to buy 100 oz of silver, but not of gold.........
I despair.
1. New techniques of fracturing have allowed substantial new reserves of shale gas to be accessed.
2. A new fleet of LNG tankers has allowed integration of world gas markets, and also access to isolated gas in places like Australia, PNG, Indonesia.
Gas is suddenly ubiquitous, and is becoming competitive with coal, which will ultimately set the price floor.
No similar technology breakthroughs have happened in oil, at least pending Amyris' plants firing up in Brazil.
The BTU relationship doesn't work so well because gas is more difficult to store for vehicle transportation.
But given the likely ongoing gas/oil differential, expect to see wholesale conversion to gas in countries like the UK where some filling infrastructure is in place and conversions are cheap.
We are entering the gas age.
Sen Stoolexpert has just introduced a bill that will make it Illegal for the price of oil to go up beyond a price X which is the square root of his contributors energy inputs divided by 3 and will make it Illegal to Ever sell any financial stocks.No Naked Short Selling, hell Why Not Just No Selling?
Problem solved, non?
As someone that works in the energy sector this is absolutely a relationship. Take a look at peaking plants throughout the U.S. the are usually duel fired (GE LM6000) that use either nat gas or oil for the purposes of hedging against commodity and transmission costs, among other things.
Carbon tax will "relocate" the arb. Great leap into deficit reduction (and QE "whoaa Benny"!).
anyone notice the m&a vacuum in this sector? i don't think any operator honestly believes that oil at 72 and a 12 month nat gas strip 150% higher than spot is reflective of supply/demand. nothing has collapsed in this space (yet).
Essentially all dual fied peaking plants in the U.S. are already burning natural gas b/c as the relative prices ran away from the 6:1 Btu relationship years ago. These peaking plants are the Oil/Gas physical arb mechanism and they are already 100% on gas, so there is no more physical arb left.
There simply is not enough natural gas used in the transporation market to bring down oil in the medium term. (Long term, who knows? Maybe we get more natural gas cars & trucks.)
There are still bunker boilers that can be converted to gas, but it takes some cap ex, and there isn't that much of it.
Home heating has been transitioning to gas for some years, but this is a pricey change for a homeowner, especially a debt laden home owner, so I wouldn't count on that helping.
OTOH, there is a physical arb between gas and coal as well as utilities can choose to run the gas peakers more and run coal plants at lower utilization. This has been the case for 2009. As noted in comments above, eletricity demand is down due to the fall of in industrial demand. Most of this reduction has been in coal fired generation. Nat Gas electricity generation is actually flat 2009/2008. This swing from coal fired production to gas fired production has supported gas demand by about 2bcf/day out of the ~60bcf/day total used in the U.S. Steam coal prices are in the toilet as well and stock piles at utilities are at all time highs despite massive production cutbacks by coal miners.
In sum, the physical arb between oil & gas is dead as it has been so far out of whack for so long that there is effectively no one left to switch from oil to gas who hasn't already done so. It would take a substantial shift is usage with years of investment for gas to encroach on oil's key market - transportation. That, in my mind, is the only thing that would cause gas to be priced near oil in btu terms.
Oh yeah, all the wind production coming on line isn't going to help gas or coal either.
The coal/nat gas relationship is the new black in energy.