Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
about today’s futures markets. To submit a question, post your question
at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C. Visit Garner at www.DeCarleyTrading.com. Her books, Commodity Options and A Trader’s First Book On Commodities, are available from FT Press.
ENERGY BASICS
If I want to get into trading energy futures, where can I go for fundamental information?
There is a saying: “Nobody has ever fought a war over ethanol.” Nobody ever has done so because there is no reason to. Ethanol is created with renewable resources; unfortunately, more popular forms of energy, such as crude oil, are not renewable. Due to oil’s finite supply, interruptions in extraction, transportation, or distillation can create volatile price movements. Nothing tells the story of this better than a chart.
The price of crude oil futures peaked near $150 per barrel in mid-2008 (if you recall, many pundits were calling for $200 oil in short order) and retreated to around $30 by the end of the same year. This equals about $120,000 per contract. This is one of the most treacherous commodity markets to participate in but remains popular due to the potential rewards.
Supply/demand factors
For production and usage figures, energy traders look to the Energy Information Administration (Eia), which is a section of the Department of Energy (Doe). The government entity issues periodic energy statistics and even market predictions.
Annual forecasts
The Eia releases an annual forecast of crude oil prices based on extensive calculations using estimates of economic growth or contraction, demand for the product, potential substitutes in the marketplace, and inflation. Their predictions are typically long term and can span decades.
Perhaps the most compelling lesson a finance major learns in college is complex equations and pricing models are only as good as the data used, and let’s face it, economics comes down to an educated guess. In other words, use the Eia predictions as an indicator of what might happen, not the holy grail of price prediction.
Weekly inventory
Each week, light sweet crude oil traders at the New York Mercantile Exchange (Nymex) look forward to the release of the government inventory report. The Eia report details refinery activity, current stockpiles, imports, and even prices at the pump.
The information on the Eia’s findings is released to the public every Wednesday morning and is almost always met with volatility. In fact, risk-averse traders often flatten positions prior to the announcement, and aggressive traders hope for windfall profits by positioning ahead of the announcement. Either way, it is important to be aware of the report’s time of release to ensure that you are effectively managing risk exposure based on your tolerance.
Opec
Most of us are aware of the Organization of the Petroleum Exporting Countries, better known as Opec. The cartel, which is composed of 12 countries (Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela), has enjoyed the luxury of price controls since 1965.
Headquartered in Vienna, Austria, Opec pledges to pursue stabilization of international oil markets but does so in a manner that best benefits its member nations. Simply, although they are in competition with one another, each cartel member acts in a manner the group believes to be supportive of a steady income to the producing countries.
The amount of price influence on the market by the 12-country cartel has diminished in recent decades by the discovery and development of large oil reserves in the Gulf of Mexico, Alaska, Canada, and even Russia. However, Opec nations still account for about two-thirds of the world’s oil reserves and about a third of production. Naturally, this affords the group a considerable amount of clout.
Nonetheless, as industrialized nations scramble for alternative fuels, Opec’s control seems to be slipping. During the heyday of the 2008 crude oil rally, there was speculation that some cartel members were overproducing to take advantage of inflated pricing, working against the goals of the organization. Despite this, it is difficult to imagine a world in which Opec doesn’t have a strong grip on energy prices; therefore, as a commodity trader it is important to be aware of the cartel’s policy, predictions, and tendencies.
US dollar
Despite pleas against it from time to time, global crude oil is quoted in terms of the US dollar. A higher dollar tends to put downward pressure on dollar-based assets such as crude oil; conversely, a weak dollar promotes higher prices. This is because a cheaper dollar makes crude oil more attractive to overseas consumers and therefore increases demand for the product.
It isn’t a coincidence that oil is priced in dollars. The US is, by far, the largest importer of crude oil in the world at approximately 11 million barrels per day. Japan comes in at a distant second at 4.6 million barrels per day based on the final 2008 figures.
Although the US does produce some oil in regions such as Alaska, the Southwest, and the Gulf of Mexico, it isn’t even on the map of the largest exporters. Saudi Arabia exports approximately 8.5 million barrels per day and Russia nearly seven. The remaining supply is provided by a handful of smaller exporters in the Middle East and South America.
As volatile as the US currency has been, it is arguably the most stable and liquid of the denominations used by major oil players. It will likely be difficult for protesters of dollar-based asset pricing to get their way.