The only way is up?

By Benedict De Meulemeester

By Benedict De Meulemeester on 21/10/2009

At the end of last week, the oil price broke through the 75 dollar per barrel level that had been the resistance level for some months. At the moment of writing these words, the Brent price is at exactly 77 dollar per barrel. At first sight the oil markets seem to share in the bullishness which has been observed in stock markets recently. On the other hand, the positive mood is much more prudent than the reckless upward shocks that we saw in 2007 and the beginning of 2008. The oil price is no longer racing uphill at a rate of 5 - 6 dollar per day.

This seems to be logical if you consider the current macro-economic context. Yes, there is some more positive news n the world economic front. But on the other hand, it is also clear that recovering from such a deep recession is not an easy, straight-line process. The small-step but continuous rise in oil price since February however has brought the oil price significantly higher. The 77 dollars that we see now is almost double the low of 39,55 that we saw on the 18th of February.

An important element to consider however, is the contango effect. The oil price that you read about in the papers is the month ahead oil price, i.e. the price of the futures contract for the next month for which futures contracts are traded. Today, with the 77 dollars, that is December 2009. In February, with the 39,55, that was April 2009. And what is important is that at that moment, the April 2009 contract had dropped a lot more than the December 2009 contract, which was trading at 46,28 dollar per barrel on the 18th of February. This is due to the contango effect that we have observed all year long in the oil markets, meaning that futures prices rise the further you go into the future. From this perspective, the oil price has not doubled, but risen by 66,9%.

Second element to consider for European buyers of oil and gas prices linked to the oil price, is the currency effect. On February the 18th, you could buy 1,2537 dollars with 1 euro. Yesterday, this had risen to 1,4939. This means that the December 2009 contract was worth 36,91 euro per barrel on February the 18th and it has now risen to 51,54 euro per barrel, a 40% rise. This explains why oil-indexed gas prices for 2010 have not doubled.

Still, a 40% rise is considerable. The reasons are unclear. It is provoked by falling dollar value. The correlation between euro/dollar rate and oil prices seems to be one of the few that has survived the crisis. Colder weather conditions in key consuming reasons could be another reasons. Or maybe, we will find out in a few months that the Chinese are consuming more oil again. I'll let you know.

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