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Oil Market Speculation Argument to be Tested by WTI Rollover Cycle
By Dian L. Chu, EconMatters
The monthly roll cycle starts Tuesday April 5th for Crude Oil with the 4-day rolling of USO positions, the USO is an exchange traded security meant to track movements in the WTI futures contract. This happens over a four day period now from the 5th-8th of April, so that traders cannot easily front-run the rollover process.
Rolling, Rolling, Rolling - USO, Brent & WTI
Nevertheless, obviously with the price of Crude rising, the USO has to sell a lot of front month longs in the May contract to rollover to the June contract. Based on the listed holdings as of Monday April 4, USO will roll over 8,400 WTI Crude Futures for the May contract on the ICE exchange, and also has to rollover 8,821 CL Crude Futures for the May contract on the Nymex exchange, and 2,000 Crd. Oil Fincl. Futures WS for May also on the Nymex exchange.
Next we have the Brent contract Rollover schedule which begins with options that expire on the 12th of April with the futures contract expiring on the 15th of April. However, expect traders to position ahead of the actual expiration date as most traders will roll their Brent futures contracts sometime between the 8th and the 13th and for options the 8th through the 12th serves as a good rule of thumb.
For the WTI rollover we have options expiring on the 14th of April, and futures on the 19th of April, but again most of the rollover takes place prior to the last 2 days of the date of expiration. So expect most traders to rollover positions somewhere between the 12th through the 15th of April. For options activity it would be the 12th through the 14th.
Trader Rolling Technique
The roll methodology can take several different directions according to trader`s expectations. Besides the procedural roll of the USO, which over 4 days they sell May contracts and buy June contracts in the same instruments; however, for the rest of the traders there is more discretion involved.
For example, often times traders know that a large base of positions have to be rolled over, so they close out their positions, and wait for the selling to end before then buying the next month`s contract to keep their original bias in the market. Some traders even short the market at the same time they are closing out their original longs because they know that a large roll of longs will be closed out, so they piggy back on the rollover for additional profits.
This is oftentimes why you experience 4 or 5 days of weakness due to the selling, and shorts piggybacking on the rollover, with two days of strength in the expiring contract as the shorts have to go long to close out their positions before the contract expires.
Recent Rollover Pattern
If we look at recent contract rollovers for the last several months, the pattern has been to move up the futures contract from the last two days of the expiring contract, and right up until the USO starts the entire rollover sequence again. As such, most of the gains for each new month come right at the beginning of the next month’s contract being the front month.
The reason for this is apparent, as new money can come into the contract with new positions without the worries of having to rollover their position or take physical delivery. Again, we saw this with this month`s contract, so the pattern is holding.
Test Case for Market Speculation
However, we have an interesting test case for markets, and the long standing argument that markets are never run-over by speculators, because in the end, all market participants have to take physical delivery or close out their positions, so they cannot affect price over the long term.
Well, with Cushing inventories at record highs, literally bursting at the seams (see charts below), and only going to get worse over the next two weeks, and given the fact that the WTI contract is deliverable at the Cushing hub, we will finally test whether that hypothesis is true.
No Storage = Close Out Long Positions
In other words, there is no way traders can take delivery on enough crude for the expiring May contract to not go down from current levels, because there isn`t sufficient storage capacity. Anybody who opened a new position for the May contract, and there were lots of newly created long positions with a rising oil price for this contract, must close out these longs by selling the May contract, thus making the front month go down.
The reason it is a test is that unless traders arrange for a bunch of tanker trucks to back up to the Cushing hub, which is mighty expensive and cumbersome, also considerations of what you do with the Oil after taking delivery, i.e., major additional transportation and storage costs, and the WTI contract doesn`t go down, we now know that the taking physical delivery argument is an invalid argument.
Spotlight on Speculators If Oil Price Still Moves Up
Moreover, there are ways to move up futures contracts without taking physical delivery. All of which would shine a bright spotlight on the role and power of speculators in driving up Oil prices, and how previous regulations have failed to address the major divergences between the underlying supplies in the market, and the prices reflected by the futures contracts trading on the exchanges.
It seems that if we look back at 2008 where Oil prices basically went from $143 to$33 a barrel in six months, and Oil being a rather inelastic commodity, that some of the practices that go on in regard to speculation in this commodity, have been stubbornly neglected and overlooked by regulators.
Oil Market - Vegas Style Casino
If these boom and bust price spikes continue, they are not truly reflective of underlying fundamentals. As they push markets in both directions far past the underlying supply and demand dynamics of the market, this price instability isn`t good for consumers, producers, exporters, importers, refiners and the global economy.
Having a healthy, stable Oil market devoid of excessive speculation is in everyone`s best interest over the long haul. What the regulatory framework needed to accomplish this lofty goal is another matter entirely.
However, one thing is for certain--the Oil market reflects more of the characteristics of a Las Vegas Casino game, and less the characteristics of a hedging instrument used for legitimate price discovery of the underlying commodity reflected by supply and demand fundamentals in the marketplace.
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I hope all you cowboys covered your shorts....Can't say I didnt tell you so....
Thanks, very useful - I now know when to add to my longs.
Items:
1) GOM's hurricane season starts now.
2) KSA's summer air conditioning burns 600K bpd that is not burning this moment.
3) Suncor in Alberta has scheduled its normal periodic maintenance on one of its big oil sands upgraders (150K bpd) for May. It will shut down that amount of production for 6 weeks.
4) Nigeria has an election near. The last one in 2007 shut in half their 2 mbpd production.
Cushing cake without dry raisins...grapes of froth...on the menu...bubble times with dips and climbs...hang in there but don't overtake on a bend. It's dangerous...One million barrles away from a spike, or a nose dive.
legitimate price discovery ? LOL
times there are a changing' and Cushing is a fake !
The way I see it is as follows. If you have an auction where every participant has $25. No item will be sold for more than $25. Give everyone $100 and prices will be bid up to possibly $100. This is what's happening, more dollars chasing the same amount of goods. This is definitely a result of inflation, created by QE.
Take a close look at the mismatch between quality of crude on the market and the quality of oil that refining capacity is optimized for....
You really believe that`s why crude oil is up 35% from last year with the same marketable crude oil to refinery setups more or less. Your dumb as a rock!
And that`s why if Bernanke said tommorrow morning that QE2 will be cut short, and they have decided to raise the fed funds rate by 50 basis points - would these so called mismatches still be in place?
And where do you honetly believe Crude Oil would be trading tomorrow - $10 dollars lower, and $20 dollars lower in a week. Gold would have a $100 down day, followed by an absolute carnage of selling. It would be so bad in Silver that the market would be halted several times. Forget about 5% down days in Silver:)
You can talk your book, that`s fine......but don`t be stupid about it....at least know why you are making money. The reason Crude Oil is where it is today is the same reason Silver is where it is- The Jet Fuel provided by QE2.
You do realize the following tidbits:
1) Since 2005, Net Exports are down 10%. Producers are using more of their oil at home reducing the amount of oil on the market. You were aware that Egypt became a net oil importer in 2009? And that Mexico is slated to become one in ~2015? And SA are down over past few years?
2) The energy content of "All liquids" which is reported as "Oil Production" by the IEA, EIA etc... has been flat since '05 despite the volumetric gains from NGL, Refinery gains and the like. It is like the world gas tank is full but it is progressively E5, E10, E15....
3) Of the ~40 mmbpd that is on the export market, Chindian import demand has increased from 11% to 17% of net exports since 2005.
4) There is no refinining capacity for the crap that the Saudi's are putting on the market to replace the shortfall from Libya... Price inelasticity gives 1% shortfall leads to a 16% increase in price, Libya is ~4% of world net exports..
WTI is the one oil index that is completely skewed relative to all others.
http://www.upstreamonline.com/marketdata/markets_crude.htm
And yes, excess liquidity has allowed consumers to push up the price but it does not explain all of it...
It is never that simple and qe2 is a factor. Geopolitical events mean nothing? Lesbyan oil is the good stuff and the eurozone needs it bad. The wti sludge component is at normal demand. At the rate we devalue the dollar with ponzi, oil should be over 150 bucks. You can only manipulate real markets so much. The sauds may not like this for food imput costs for their restless population, but the big boys like exxon and bp, have to love it.
causes oil demand to outstrip supply?
Are you a slow leaner, did you not understand those supply charts---it is the other way around: supplies are all higher than their 5 year averages- Cushing, SPR, and Total US Inventories. Higher supplies than when crude oil was $33 a barrel.
There are better ways of making money than trading off the Brownian motion in a non-relevant index as far as the globe goes. No skin off my back if you do...
I trade underlying trends....less guesswork that way. Take a close look at the mismatch between quality of crude on the market and the quality of oil that refining capacity is optimized for....
Its a whole lot easier to store Gold & Silver, as oppossed to crude, there is a lot more cost involved and capacity issues right now at Cushing, this will be one interesting rollover. I will be watching the Cushing #`s for the next 2 Wednesday EIA reports to see if Cushing goes above the 43 million barrel level. If that happens CL is a screaming short moving towards expiration. Remember all those newly opened Longs taking CL from the $104 level to the $108 level, they all have to sell to close out their positions - or else take delivery where delivery cannot be taken:)
I will really make them pay to close out those longs if we start death spiraling come expiration time!
The huge ramp in oil prices could have nothing to do with the tons of excess liquidity injected into the markets by way of the prop arms of the banks in an effort to take prices higher to help the economy!
What do you think is driving the global economy which in turn causes oil demand to outstrip supply? It is called peak oil, one way to define it is that we no longer can turn paper into additional supply....
If you call a top often enough you will eventually be correct - unfortunately this is not a profitable trading strategy (esp for those trading futures without a stop loss).
The more interesting question is could the WTI price go negative (as did UK Nat Gas a couple of years ago when all available storage was exhausted).
The author said over the next couple of weeks, the spike in CL had more to do with the Yen being used rather liberally all of a sudden as another carry trade. First of all, it is an analysis....markets can stay irrational longer than your trading account can stay solvent, that`s what stops are for. There actually have been some nice short setups right at the pit open each morning. However, If you have a large enough account to swing trade CL, then a 4k loss on 1 contract and you average into a bigger position, is peanuts. On a return to the $104 level alone with 2 contracts nets you 8k on a swing position, and frankly I would say there is a pretty good chance that over the nest 8 days WTI trades back at the very least to the $104 level. It appears pretty weak now with Brent busting out, WTI didn`t follow....wonder why.......rollover.......the wti-brent spread trade is starting to be put back on....expect the spread to widen. But you should always do your own due diligence when putting on trades, these are just talking points, nothing more --no one should ever take trades based upon something you read on a website-----but always trade with stops unless you have a very large account to swing something like cl with, and even then you better be an experienced swing trader to do this in CL.
At least wait and see over the next few weeks if we have a pullback before getting your panties all in a bunch.
Let's examine this asiablues post. The author first surfaced this thesis on March 30 when spot WTI finished its Globex session at about $104.27:
"The news is only going to get worse for WTI longs, as the next couple of weeks will bring the total storage at Cushing close to the max capacity of 44 million barrels due to the fact that more traders took delivery on WTI on the last CL rollover."
Today, spot WTI finished Globex at about $108.31. Assuming some gullible trader followed the reasoning advanced on March 30, that's a 1% price increase. Translated to a margined account, that is $4040/6750 = 59.26% loss on equity.
Question: just how much does the author plan to risk to make the potential (a $14,000 per contract gain) $90 target called for in the March 30 post?
Unless these asiablues posts are sponsored, which doesn't appear to be the case since they lack the ZH sponsored imprimatur, how about Tyler exercising some editorial responsibility?
depend what margin you in use:1:10 or 1:100,if 1:10 the loss is by now is around 30%,there is no fundamentals,the FED and Government of USA try to cash on manipulations of the future markets robbing other countries vs itself,there probably was tankers on line which was storing cheap oil bought back then when it was 75-80,this was not too long back,process started recently,so,Government making money saling the oil they bought at lower prices into almost 50%,problem not with their greed,problem that this is dirty play fixing the futures markets and to put tax on everyone using food,oil,water,electricity-its all taxation
Tyler is probably assuming the readers can judge and decipher for themselves. There's no guarantee with forecasts. You either have the balls to pull the trigger or you don't. Nobody trades on blog posts anyway.
If the price goes up, so do food prices in places like the Middle east.
Used to be a time when the Saudis would welcome high oil prices. Trust me, theres people sweating bullets over this.
Yes, the middle east has oil and the rest of the world has more arable land. Tit for tat indeed.
It doesn't matter how much low quality tar sands oil is stored in Cushing. That isn't going to help the 80% of the US refiners that can't efficiently get that oil, assuming they would actually want that low quality stuff, which they don't.
BTW - Why didn't oil stop rising the last 10 times you said it hit a peak?
look at the charts. It's full of peaks and troughs. I'm sure your comment is not directed at me since i have to date not said anything about it here. Remember econ 101: cyclical. Review USO charts.
Sorry, the comment is not directed at you but the author who has bearish for some time. The supply situation is for oil right now is very bad, and unless the economy falls out of bed soon, in general oil will rise. I make no specific prediction for the next few weeks and there are always pullbacks in any market.
The way I see it, why try to make money on the short side now of anything except bonds?
I've been in TBT for 4 months and have done quite well. As I have in silver.
But that doesn't preclude other short plays. If diversifying is your thing.
Oil will crack eventually...but the shorts covering will be the blow off spike. Fundamentals on world supply, not WTI, suggest 115-120 for Brent. If the rollover leads to a $2.40 sell off, BFD, 2-5% tops, there are better shorts out there. Why not buy cheap airline calls? Or sell USO call spreads? Much better risk reward in my book.
Flak: peruse the DTO charts. If you believe oil will be at 115 then stay away from DTO. But if you believe oil will re-settle anywhere in the 90s, then DTO will reward you much better than any airline call.
I'm still on the fence. I don't believe oil should be at 115 until mid-late summer. Could it return to 90s? That's the mill $ Q.
Well this is what makes a market, n'est pas?
Economic slide back first, then short.... We ain't there yet, there is still enough warm economic fuzzies and liquidity in the system... Slowdown, then, 90. Currently demand needs to drop ~1 mmbd to bring it into balance with supply. What matters is the marginal cost per barrel of demand
I posted then 6 months ago, never short crude when the Brent-WTI spread widens. It is widening of late...
I'm strongly considering DTO as my USO short ETF play sometime this month -- mid to late april as this is historically an USO correction period. (Mid Feb spike/surge inverse analogue.)
I believe oil will be manipulated down for mid to end of April with Obama positioning plus QE3 machinations plus profit-taking as function of physical delivery/rollover. Libya will be "stabilized" by mid to late April as reported by mainstream media and other factors such as summer (where new spikes will have to be generated [a trough helps for that] and by which time you will be out of DTO and back in USO; etc.).
I could be completely wrong here. But this is my position.
oil is like the secret sauce that makes everything better
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so when things are crazy man i mean real crazy prices and everything man
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look out-secret sauce