I've watched and traded the oil markets for 25 years and the recent huge speculative inflows of money driving oil and gas prices higher are reminiscent more of the move I saw in 1991, when we were on the cusp of the first Gulf War with Saddam Hussein. Is this market trying to price in a similar event?
Most analysts are comparing this latest run up in prices in energy to 2008, when we also saw a speculatively driven run-- that time to $147 a barrel. As I describe in my book, Oil's Endless Bid, in both cases we have not had the reality, but instead the perceptions of supply or demand problems driving a rapacious flood of betting into the futures market from institutions, hedge funds, investment banks and even individuals.
But the way that this money is flowing in is telling of the big difference in the motive that I think I see: This time around, the curve of oil prices looks strikingly less like 2008, and much more like the market I saw in 1991, during the run-up to war in Kuwait.
Oil futures are not priced like stocks but in futures months that continually expire. Each month is a tradable issue in itself and prices independently. The relationships of those monthly prices make up the 'curve'.
For the past 5 and more years, the oil market has had a predominantly 'contango' curve; that is, the oil in the future has priced at a marked premium to the oil pricing today. But in the last month or so, the curve has slowly but surely 'flattened' out, and now the traded prices for crude twelve months from today are actually lower.
Ok, this is all very wonky, but what the market is really saying is that it is betting on a short but very serious disruption to supply, one that is not expected to last -- like a war.
So, what kind of specific disruption could this market be expecting? I don't know, but two possibilities that might fit this bill might be the commitment of ground forces in Libya, or a real disruption from protests in Saudi Arabia, where the US government would again be in a very delicate spot and forced to support the Sheiks of the Kingdom to an even greater degree that they have supported dictator Saleh in Yemen, no matter how reluctantly. Libya's 1.6m barrels a day of supply is manageable, while Saudi Arabia's 10m barrels a day (and 4m swing barrels) would be instantly game changing to the global marketplace.
How deep that support turns out to be and whether military force will be part of that commitment seems to me to be the big bet that the oil markets are making right now.
The run-up in crude is now moving in bigger and bigger leaps -- up another dollar today, above $110 in the US-based WTI and closing in on $125 in the European Brent contract.
I'm not predicting it, but this market seems to be looking seriously at the future possibility of even wider and more serious oil problems down the road. It ought to be an interesting summer.
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