The fastest growing bet in the oil market these days is that the price of crude will double to $200 (Rs7,860) a barrel by the end of the year.
Options to buy oil for $200 on the New York Mercantile Exchange (Nymex) rose 10-fold in the past two months to 5,533 contracts—a record increase for any similar period. The contracts, the cheapest way to speculate in energy markets, appreciated 36% since early December as crude futures reached a record $100.09 on 3 January.
While analysts at Merrill Lynch and Co. Inc. and UBS AG say the slowing US economy will lead to the biggest drop in prices since 2001, the options show some traders expect oil to rise for a seventh straight year. Demand will increase 2.5% in 2008, according to the International Energy Agency (IEA). US inventories fell to a three-year low on 28 December. Production from Mexico is declining and Saudi Arabia is behind schedule in opening its newest field.
“One hundred dollars a barrel is actually 14.9 cents a cup, so we’re still talking about oil being remarkably cheap,” said Matthew R. Simmons, chairperson of Simmons and Co. International, a Houston-based investment bank that focuses on energy. Inventories “are tight as a drum and I don’t see how we get out of this box,”he said in a Bloomberg television interview last week. “Demand clearly isn’t starting to slow down.”
World consumption will rise to 87.8 million barrels a day this year—2.1 million more than in 2007, or about the same amount that Nigeria supplies, according to the Paris-based IEA, an adviser to oil-consuming nations. Demand from China alone will increase 5.7% to 8 million barrels a day as imports expand to support an economy that’s likely to grow 11%, IEA said.
Oil suppliers are straining to increase production. Saudi Arabia, the world’s largest exporter, said last week that the 500,000-barrel-a-day Khursaniyah oilfield missed a December start date. Brazil’s Tupi field, the second largest find of the past two decades, lies more than 8km below the ocean surface and will take at least five years to develop.
Petróleos Mexicanos, Mexico’s state oil monopoly, suffered a three-year, 40% decline at its Cantarell field—the world’s third largest. Fighting in Nigeria reduced production 11% since December 2005 to 2.18 million barrels a day, according to data compiled by Bloomberg.
Crude futures rose 2% in the first three trading days of the new year, closing at $97.91 a barrel in New York on 4 January. Crude inventories fell to a three-year low of 289.6 million barrels on 28 December, according to a 3 January energy department report.
“We haven’t got to $100 on just a whim,” said Paul Horsnell, head of commodities research at Barclays Capital, the investment banking division of Barclays Bank Plc., in London. “This is at heart also about longer-term concerns that supply capacity investment needs higher prices to keep up with demand growth.”
Barclays forecasts oil will average $87.40 a barrel this year—a 21% increase from the 2007 average.
Nymex options, which give speculators the right to buy 1,000 barrels of oil in December, are becoming a favourite for traders even if they don’t expect crude to reach $200 because they are a cheaper way to speculate than using futures contracts. Options expire worthless if crude fails to reach the “strike” price. There were 500 of the options on 7 November.
The price of the options rose as high as $550 last week before closing at $300 on 4 January. That amounts to 30 cents a barrel. The December futures to purchase 1,000 barrels in December rose 3.5% to $94,010, or $94 a barrel.
“The most common analogy used to describe options is that it represents insurance” against “low probability” events, said Tim Evans, an energy analyst at Citigroup Global Markets Inc. in New York.
Oil forecasters said there’s no chance of $200 crude, because the US, which consumes a quarter of the world’s oil, slows. Prices will average $78 a barrel this year—20% below the current level, and $75 in the fourth quarter, according to the median forecast of 27 analysts surveyed by Bloomberg. The last time prices fell that much was in 2001, when they dropped 26%.
Merrill Lynch and Morgan Stanley in New York expect the US economy, the world’s largest, will slip into recession this year. The jobless rate rose to 5% in December—the highest in two years. The Institute for Supply Management’s factory index fell to the lowest level in almost five years in December.
The US probably expanded 1% last quarter, according to the median estimate of 63 economists surveyed by Bloomberg. Gross domestic product will grow 2.3% in 2008, the survey showed.
UBS, Merrill forecasts
Oil is overpriced, given the outlook for the economy, said Jan Stuart, an analyst at UBS AG in New York. Stuart forecasts an average priceof $74 a barrel this year— little changed from 2007. Merrill Lynch’s Francisco Blanch predicts $78 in the fourth quarter.
“I am afraid that we are going to see an economic slowdown that we have not seen the beginning of yet that will take some significant amount of oil demand off the table,” Stuart said in a Bloomberg television interview on 2 January.
Most strategists didn’t foresee last year’s 57% gain. Crude traded at an average of $72.36 in 2007. A Bloomberg survey of 29 analysts in September 2006 forecast a median price of $64.
“Going through $100 means that people are seeking more protection against a higher number,” said Michael Lewis, a strategist at Deutsche Bank AG in London. Deutsche Bank expects oil to fall to about $80 a barrel. Options trading indicates that the likelihood of crude reaching $125 a barrel in December has almost doubled since 25 December, to 18%, Lewis added.
While $200 may remain an outside chance, Simmons at Simmons and Co. showed he’s willing to make that bet. He wagered $5,000 with The New York Times columnist John Tierney in August 2005 that oil would average at least $200 a barrel in 2010.
The latest assessment from the Organization of Petroleum Exporting Countries (Opec), which produces 40% of the world’s oil, suggests prices will rise. “There is enough oil in the market,” Chakib Khelil, the current president of Opec, told reporters in Algiers two days ago. Khelil, who is also Algeria’s energy minister, said rising prices aren’t Opec’s fault. The group is scheduled to meet on 1 February.
“You will see even $200 oil in the next five years,” said Jean-Francois Tardif, senior portfolio manager at Sprott Asset Management Inc. in Toronto.
Mark Shenk, Ken Prewitt, Pimm Foxx and Alberto Riva in New York; Rishaad Salamat in London and Ahmed Rouaba in Algiers contributed to this?story.