COMEX Futures Losing Relevance As Global Benchmarks

FT Alphaville reports that 'WTI about as useful as a chocolate oven-glove'. Basically, speculator are wrecking havoc with futures markets in the US, and commercial end users are beginning to look at serious alternatives. COMEX futures are losing their position as the global benchmark for commodities and can now be considered the playground of overleveraged clueless hedge funds.

(emphasis mine)

'WTI about as useful as a chocolate oven-glove'

As FT Alphaville has been reporting for weeks now, WTI has lost is losing its position as the global oil-price benchmark.

In case anyone still disputes the fact, Thursday's WTI/Brent spread has reached a preposterous $9 dollars. As the FT's trusty energy correspondent Javier Blas informs us, that's the widest spread in 17 years.

Meanwhile, the differential between WTI and other US grades is widening too. The Mars blend is trading $1.5 above WTI, which is amazing considering it is a medium-sour crude, while Light Louisiana Sweet was trading as much as $8.30 per barrel more than WTI. This follows another epic build at Cushing, Oklahoma - the physical delivery point for Nymex WTI. The facility is now holding a record 33m barrels, which means it only has about 1m barrels of capacity spare.

Until the Cushing scenario is resolved (unlikely until the contango in WTI disappears), the Nymex light sweet crude contract remains a pretty useless global price benchmark. Paul Horsnell, from Barclays Capital's commodity research team agrees. In fact he puts it even more eloquently (our emphasis):

The dynamics of the US crude oil market have become increasingly bizarre in recent weeks, and have now reached the point where the US crude oil price mechanism itself has got stuck in a fairly vicious loop. The mechanics of the market, and the logistical compromises that have had to be made to generate a market price along a pipeline system, are themselves creating additional distortions. Those distortions are, in turn, feeding back into ever greater stress on the market mechanism. That feedback is creating a wild thrashing about in the front end of the WTI curve, and an increasingly dislocated and disconnected set of time spreads.

As that effect has grown, in terms of being a reflection of general market conditions, WTI has become about as useful as a chocolate oven-glove. Please feel free to insert any other comparison of your choice with something that is perhaps not best fitted for the purpose. Most important, WTI is currently sending the signal that it is all but impossible to arbitrage across either time or region. Front month spreads of $7 per barrel (see Figure 18) and Brent-WTI spreads also of $7 per barrel (see Figure 15) are so far away from any sustainable equilibrium that they imply a mounting degree of market breakdown. This is not the first time this has happened with WTI; it is, however, the most severe instance.

The view from JBC Energy meanwhile is:

Such a wide spread is making it much more difficult to import foreign Brent-related grades such as Russian Urals and West African Bonny Light. With so much crude stored in landlocked Cushing and not enough pipeline infrastructure to redistribute it, WTI Cushing has once again become dislocated from other US grades .

So there you have it, WTI is broken and, in our opinion, irrelevant as a true indicator of the global oil price. Can the oil price is falling scare-stories please stop now? At the last look Brent was trading at $47 per barrel.

The Financial Times reports that commodities investors are being hit as oil benchmarks diverge.

Commodities investors hit as oil benchmarks diverge
By Javier Blas
Published: January 14 2009 19:55 Last updated: January 14 2009 19:55

The price difference between the world's two main oil price benchmarks — West Texas Intermediate and Brent — widened on Wednesday to a record as inventories at the delivery point of WTI, in Cushing, Oklahoma, surged to an all-time high. ICE February Brent traded at a record intra-day premium of $8.46 a barrel over Nymex February WTI, well above a previous peak of $6.60 a barrel set in May 2007.

Traditionally, lower quality Brent trades at a $1.50 discount against WTI.

The rare divergence is causing hefty losses to commodities investors, particularly those in long-passive indices such as the S&P; GSCI — popular among pension funds — which is heavily weighted towards the Nymex WTI futures contract.

The spread is also hindering some unsophisticated hedging trading strategies used by some commercial operators such as airlines or utilities, which rely on Nymex WTI as their tool to guard against their energy cost exposure.

The widening premium came after the US Department of Energy reported that stocks at Cushing rose last week by 800,000 barrels to 33m barrels, an all-time high and closing in on maximum capacity.

Cushing is the hub of America's oil pipeline network. Because it also is the delivery point for the WTI futures contract traded at Nymex, supply, demand and inventories there have a direct — and, according to some, excessive — impact on WTI prices, often overshadowing global trends.

Oil traders said the main problem is that WTI is a "landlocked" crude oil without access to a waterborne market to relieve the surge in inventories.

WTI's problems are triggering some investors to turn into the Dubai Mercantile Exchange's Oman crude oil futures — a grade similar to Dubai oil — which on Wednesday registered a record volume activity of 6,484 contracts.

The Financial Times also reports that traders profit as ship-stored oil doubles.

Traders profit as ship-stored oil doubles
By Javier Blas
Published: January 13 2009 18:03 Last updated: January 13 2009 18:03

Oil companies and traders are storing enough oil in supertankers to supply the world for one day, in one of the most striking signs of supply outstripping demand as the impact of the economic crisis overshadows a string of Opec production cuts.

According to Deutsche Bank's oil trading desk "over 80m barrels of oil is now on floating storage", double the industry assessment of about 40m-50m last month.

Jens Martin Jensen, managing director of Bermuda-based Frontline, the world's largest operator of supertankers, confirmed the figure of 80m barrels, saying that the oil was stored in supertankers capable of carrying about 2m barrels — known as VLCCs — and in smaller tankers of 1m barrels, known as Suezmax.

"We are getting many enquiries about floating storage," Mr Jensen said. "Players are looking for anywhere from one month to six months floating storage arrangements."

Companies such as Shell and BP, and big traders such as US-based Koch or Dutch-Swiss Vitol are storing oil in tankers, with shipping brokers reporting the hire of several supertankers as floating storage in the past few days.

Mr Jensen said investment banks were joining oil companies and traders and entering into floating storage deals. Shipbrokers said that Phibro, a commodities unit of Citigroup, had also started hiring tankers for storage in the North Sea.

Traders are profiting from a record price difference between spot oil and future contracts that allows them to arbitrage physical barrels — buying spot oil and putting it into storage while, at the same time, selling a forward contract to lock in a profit.

The spread — which is in a condition called a contango, where future prices are higher than spot prices — is at a record high.

The difference between the price of West Texas Intermediate oil for immediate delivery and the one-year forward contract — a key indicator — on Tuesday widened to about $21.5 a barrel, the largest difference since US oil futures started trading 25 years ago.

The large spread is in part the result of the credit crunch, which has distorted the physical arbitrage process as some market participants — particularly private equity groups and hedge funds — cannot secure loans to finance oil storage, traders said.

FT Alphaville reports that contango in oil futures is providing incentives for production shut-ins.

The reason people are expecting a premium to sell oil into the future this time is due to limited access to credit and strong preference for cash.

As this intensifies Goldman says
producers will be increasingly incentivised to shut-in their own production.

As the contango gets steeper, breaching the cost-of-carry, it becomes ever clearer that the structure of the forward curve is providing incentives for the highest-cost form of storage, namely production shut-ins.
The "underground storage" is typically considered the most expensive because of the costs associated with shut-ins and start-ups of the oil fields and, more importantly, because it is normally far from the refinery centers.

This provides incentives for OPEC in particular to abide by their promised production cuts. The same goes for non-OPEC producers like Mexico, with news today the producer has taken steps to protect itself from further oil-price downside by locking in sales at $70 a barrel along the forward curve.

Commodity Online reports about why hedge funds are liquidating commodities.

Why hedge funds are liquidating commodities
2009-01-15 08:43:23
By Dan Norcini

It was another one of those mass long liquidation days by index funds and hedge funds as nearly everything that remotely resembled a commodity or was associated with commodities was jettisoned in favor of paper IOU's (also known as US bonds). About the only commodities that I could see that were in the plus column today were the grains, particularly the soybean market which found buying on drought fears out of South America and wheat which found support out of hard freeze fears. Corn went along for the ride. Other than that the continued idiocy in the futures markets continues with panic buying one day giving way to panic selling the next.

I know I risk sounding like a scratched CD but
the hedge funds and index funds have created near chaos in the markets with no clear, durable signals being generated- the result is confusion and volatility that gives the lie to the efficient market theory. How can markets be the least bit efficient when commercial end users and legitimate hedgers cannot even use them because of the massive amounts of price foam being churned up by these out of control funds? You'll remember that it was just a few days ago when near euphoria reined in the markets over the upcoming new stimulus plan — that euphoria sent the funds tripping and drooling all over themselves to establish longs — now we are back to manic depression and they are tripping and drooling over themselves running for the exits. Now imagine a bona fide commercial hedger attempting to formulate some sort of hedging plan to offload his risk and lock in profits while at the same time attempting to limit huge margin calls on that same hedge. My point is quite simple — the futures markets came into being as a mechanism to allow producers and end users to manage risk — that advent of speculators was designed to facilitate that end — we have now reached the point in my opinion where the entire purpose of the futures market has to be questioned. Either the regulators get off their butts and institute serious reforms in these markets, notably being a drastic curtailing of the position size of these players, or they risk having commercial end users begin to look at serious alternatives to using these markets for hedging purposes. If that were to happen in size (it is already occurring), all that will be left in the futures markets is funds playing against other funds. Then we will have nothing but casinos left. The biggest problem I see standing in the way of these reforms might very well be the commodity exchanges themselves who are now public companies and love the extra volume being generated by the incessant trading activity of the funds. That is good for exchanges SHORT term as it increases profits and makes members and shareholders happy. The problem is, like so much in the West these days, such an attitude sacrifices LONG term viability for short term gain.

My reaction: The key points to note:

1) WTI is broken and irrelevant as a true indicator of the global oil price

2) In case anyone disputes the fact, Thursday's WTI/Brent spread has reached a preposterous $9 dollars.

3) With depots in Europe almost full, "companies don't have anything else they can do, so are chartering commercial tankers for floating storage."

4) Contango in oil futures is providing incentives for production shut-ins. In particular, OPEC has incentives to abide by their promised production cuts. The same goes for non-OPEC producers like Mexico, with news today the producer has taken steps to protect itself from further oil-price downside by locking in sales at $70 a barrel along the forward curve.

5) We have now reached the point where the entire purpose of the futures market has to be questioned. How can futures markets be the least bit efficient when commercial end users and legitimate hedgers cannot even use them because of the massive amounts of price foam being churned up by these out of control funds?

(Thanks to Robert for pointing me to this story)

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0 Responses to COMEX Futures Losing Relevance As Global Benchmarks

  1. Anonymous says:

    Chocolate glove is still always useful. You can always eat it.

  2. Yohay says:

    So where can we find the real price of oil?

  3. Anonymous says:

    Try "Fart in a space suit"

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