Gregor.us

I have a question for you regarding contango and the trade that one would put on to profit from this imbalance...The USO etf tracks oil prices so given this huge contango from one month to the next, what would be the effect on this ETF once the Jan contract expires and the Feb is the new front month? Would the ETF go up or down? I can't quite get my head around this effect. I mean logically it would seem that the tracking ETF's for oil would instantly go up since oil is quoted at 33+ and then all of a sudden it's quoted at 42+? Am I reading this right? Thank you for any education you can provide on this since I'm new to oil trading...

Now that I have a blog I take care to not give any specific stock picking advice.That said, I wrote years ago on the flawed structure of vehicles like USO which get killed on the roll from contract to contract when the crude oil futures curve is in contango (every month subsequent is higher in price than the preceeding month.)

In short, there is simply no substitute for the time required to read the entire prospectus of all these commodity ETFs. There are a whole bunch of Oil ETFs and they do, in fact, operate differently. You also have to visits the websites and see which specfic contracts they are holding, and how do the roll from one month to another.

I could provide you with some of these answers. However, what I have found is that in a context of incomplete information, any answers I supply are more often misunderstood.

Therefore, my advice is as follows: research the following Oil ETFs USO and DBO. Discover how they differ from each other. Read their prospectuses and then visit their websites and see which contracts they are holding. Also, put that into context with the crude oil futures curve which you can see here.

The only satisfactory answer one can come up with on these commodity ETFs is the one you make on your own.

HTH

G

Thanks for your patience in explanation when responding to good-natured seeking of advice. A chunk of time ago, I had seen you mention DBO on twitter and have this in mind should I seek a position. I respect and appreciate your care in sharing expertise, and distinction from giving stock-picking advice.

BTW anyone interested: others have mentioned the messed up long-term internals of multiplier ETFs, where I had found the multiplier DXO when reviewing DBO from my earlier research.

While I am skeptical of Verleger's recent analysis--and it may be true that he has been sensationalist as of late in order to get press--I think you should be wary of calling him a "quack." The guy has been watching the oil markets for nearly as long, or perhaps even longer, than you (or I) have been alive. As you know, the longer you watch the oil markets, generally speaking, the more humility you've been taught in terms of predicting it. And the less you've been watching them, the less you know about what you don't know. Verleger has given counsel to the top levels of industry and government for decades now. That said, Verleger did say that the decision to continue builds at the SPR was the result of a lack of "adult supervision" at the DOE, in front of the US Senate ...

I am very wary of the Oil Drum's analysis as well. Their analysis of the Mexican and Venezuelan reserves issues completely ignore--with hostility even--potential political causes of production losses. Do you remember the trash talking on the forum that greeted Edward Morse's pronouncement that the market was in a bubble in Spring this year? He was right, of course. And, again, the guy has been watching for over 3 decades ... and he founded the Energy Intelligence Group--which produces some of the trade magazines considered must reads by some in the industry.

Quackery Update:

Hi, Another of Verleger's completely outrageous claims that he made in December was that OECD Days Supply was zooming towards 61 to 62 days supply, from the 55 days level. I truly don't think people realize how much total oil and oil products would have to pile up in OECD stocks to move the Days Supply number up by 6-7 days. To do so over even a 3 month period is nigh impossible.

The reason this is timely is that the IEA is out with today November Days Supply number and it stands at 56.4 Days Supply. Again, cannot emphasize enough how far away this is from 61-62 Days Supply, or even 60 Days Supply. (Equally, this is a HUGE build of supply from 55 Days).

As I have said before, this conforms to the Verleger pattern of quackery. It's not that he takes the outlier number, which, under unusual circumstances, could be achieved. It's that he proffers the number that it nearly impossible to achieve. And this is his record, year after year.

But Verleger says in his report that while OPEC officials think global stocks cover 55 days, the correct number is probably between 61 and 62 days, far more than the International Energy Agency has estimated.

See Platt's Barrel column of December 08 2008:

G

In January of 2006 after Bush's SOTUS speech, Verleger was quoted in the WSJ as saying the following: "All of the global demand for oil in the next 2-3 years will be met by biofuels, thus leaving the call on oil essentially flat."

I wrote to Verleger asking if he had been quoted accurately, because I thought there must have been a journalistic mistake. After all, the world neither then, nor now, was producing anywhere close to enough biofuels to cover even one half of one percent of demand growth, let alone one and a half percent. Verleger wrote back to me and said he was indeed quoted correcly.

That is quackery and Verleger makes absurd claims like that all the time.

You think I should be more careful to not assert quackery in someone like Verleger. I used to think that too. But now I think differently. Verleger is part of an enormous, societal problem we have here in the States that has been going on for decades where leaders and experts are given a level of respect that has greatly outdistanced their value to society.

Notice for example how you yourself invoke Verleger's resume and his past experiences as a way of suggesting that he deserves more respect. I say no. I say: all that is over now. Whether in Journalism, Finance, Government, Monetary Policy, or in Academia, what the last 20 years is showing us is that US leaders deserve less respect, not more. They deserve more skepticism.

I think that's what this crisis is about. Right here, right now. There is a huge problem that has developed in the culture over the concept of expertise, and who gets to claim expertise and who doesn't. And it's enabled by the rest of the culture's assent to the Regime of Expertise.

Why do you think Verleger's decades of watching the oil markets has intrinsic value? Isn't it more than just a little bit crucial to what extent he is able to process that information? How do you think experts like Alan Greenspan will be treated by history? How about Ben Bernanke--who by his own admission never saw that there was a credit bubble?

G

Well, did you read the Senate testimony Verleger provided regarding the price environment in late 2007? You may well disagree with his conclusions while at the same time taking note of some important points.

I do not think that the culture of expertise is at the root of the emotion symptomatic of the zeitgeist. In fact, I think that the GOP went out of their way to place people without any expertise whatsoever in positions of authority for near 7 years. It has been boom times for tactically-driven yes men general all over the US.

The accounting companies, their prognoses were--and are--worthless. It is no surprise credit is not being extended, no one knows whats on anyone's books and everyone knows that it's hidden because they hid it themselves.

That said, I know, due to my experience, that nearly everything I read in the press about the oil markets is sheer nonsense. This is because journalists tend to have very little expertise as a general rule. Perhaps you've tried to explain something about the oil markets to someone else in the face of what they've read in the papers. A frustrating experience just getting someone to hear expertise sometimes, no?

Hi,

I have indeed read Verleger's testimony to Congress in late 2007. I think it was December 0f 2007. In a general sense, I thought his assertions were reasonable. But where he went off the rails was in concluding that the sole reason for oil's rise was the Fill program to the SPR. In making this conclusion, I think it fits the Verleger pattern. He makes some decent observations, and then he goes off the road into a ditch on his conclusion.

As for Ed Morse, Ed was correct that oil prices would fall. I don't actually recall Ed asserting that Oil was in a bubble. My view was, and remains, that oil was not in a bubble. If by bubble, one means an investment bubble, in the sense of the history of investment bubbles, then no--oil was not in a bubble.

I have written on this topic. Some think its a distinction without a difference. But, I disagree with those who think that. Generally, consumable commodities have large price swings that are not the result of an investment phenomenon but rather the result of the structural nature of physical commodities and the phenomenon wherby the ability to extract them and get them to market is not smooth.

It's possible that oil was in a bubble in the sense, however, that the entire world was in a generalized bubble so that everything from London real estate to share prices to Fine Art to Copper were all in a bubble created by credit. However, if this is what one is asserting, then it is far better imo to simply say that there was a global credit bubble that lifted the nominal price of all assets globally.

Ed Morse's reasoning, btw, was not that sound. In the same way that one can have weak reasoning that oil prices will go higher, and then claim one was correct when they went higher, so too have many claimed being correct in the wake of oil's fall.

As a student of history and geo-politics, I am sure you would favor the better argument as to why the Soviet Union collapsed, for example, than the weaker argument or prediction of same.

Neil King at the WSJ has been pretty good this year on oil. Jad Mouwad has lagged, but he is getting better. It was not until 2004/5 that US based journalists even paid attention to oil and commodities. Papers in London like the FT were on the case much earlier.

G

You're right, it's technical. Kinda like the close on September 22.

Moreover, 2.46 mb/d is not a trivial production cut. The supply elasticity that Verleger was mooting to justify an end of sweet light additions to the SPR was -0.04, if I remember correctly. A supply cut of 3.1% of daily global demand should have an effect, even without such extreme supply elasticity estimates. Now he thinks global demand is down 6% ... ?

I imagine everyone will be watching to see how much will in fact be cut, by OPEC and Azerbaijan. Including other potential reducers of supply, Russia and Kazakhstan, no less.

But you should mention Thunder Horse going fully online today and the EIA touting that particular story ... part and parcel of their estimate that non-OPEC production will grow considerably next year for the first time in some time. That, inventory gains, demand destruction, and a refining capacity glut re: gasoline are part of this story. Front month RBOB over front month CL moved over $7/b to a margin of +$4.22/b in the last 7 days. RBOB futures are not telling the same story as CL, nor are NG or, for that matter, HO.

Hi,

FYI, Verleger is a quack. His only aim is to assert the most extreme forecasts and numbers, to get attention. HIs record in this regard is strong, especially the last few years. I have held back on doing a post just on his calls. But I may.

Back in the world of reasonable persons, however, yes it's true that Thunder Horse is coming on line. I think it will revive the GOM which endured another set-back from this year's hurricanes. THunder Horse also shows a winnowing trend in the GOM, which has seen small operations disappear since 2005, owing to economics, insurance costs, and the weather. This was all predicted pretty well by some people over at the Oil Drum. So, as we go along, we will see that GOM production migrates more towards operations of the kind like T.H.

It will do nothing for non-OPEC production as a whole, however. non-OPEC production is crashing. The natural declines were already with us, and now price in 2H 2008 is finishing off the job. As you may know, I believe we are at risk of losing 9.00% of non-OPEC production by next year. That would take it down towards36 Mb/day. If you look at this chart, non-OPEC already started in on this drop in August and September.

ANd yes indeed, the cracks are suddenly looking great for the refiners.

Correction: "....take it down towards 36 Mb/day"

Interesting. Thanks for pointing out the line-up. The snap up seems less likely than the domino roll down for sometime. Just throwing that out there seeing if you'll bite onto a prediction, completely listing you as the expert way above me :-)