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The Message of the Market

by Jeff Miller, CEO, Gas-Lock Advisors LLC
(click to enlarge)
forward_curve.jpgThe crude oil futures market carries a message—one that we monitor constantly. The price of oil you see quoted in the news is the front month spot price, usually for Texas Intermediate crude oil. There is trading in futures for delivery of oil years from now. A contract for delivery in Dec. 2012 will trade continuously until it expires.

If you arrange all of the contracts in a chart, you can see not only the current price of oil, but what market participants expect for the future. This is called a “forward curve.”

In this chart (see above) we show three forward curves. The bottom curve is from two years ago. Oil prices were close to $40/barrel, but this was viewed as temporary. The forward curve falls close to $30/barrel within two years, and below that level soon afterward.

By 2005 the situation was dramatically different. Not only was oil trading for more than $50/barrel, the expectation was that prices would move higher over the next six months.

traffic_1.jpgMoving out several years on the curve, the expectation is that prices would fall slightly below the $50 level.

In the 2006 forward curve, we see the implicit market prediction that $70/barrel is here to stay. Prices are expected to move above $75/barrel before going lower.

In short, the market is telling us that current pricing is not just a temporary spike, and that the near-term risk is for higher prices.

Future columns will discuss the trading behind the curve—the players and their motivations.

(This article was previously published in the print version of “Pumps,” vol. 1)

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