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Trading Peak Oil - The trade of a lifetime?

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If spot oil continues to slide, the long-dated futures may get dragged down further.

 

They will, but I am not worried, because the short term price of oil is ultimately not relevant for this trade. What matters is whether oil will be above $62.40 in 2012.

 

It is interesting how the longer dated futures react in different markets:

 

1. Natural Gas: The long dated futures show slight backwardation, meaning it is cheaper to buy a long dated future than a short dated one. When the short term futures move, the long term futures hardly move at all. This seems naturally right, because why should short-term fluctuations in stocks and demand have any bearing on prices 5-6 years down the line?

 

2. Oil. The long dated futures show slight contango. The six year out contract typically trades about $4 above the near month. This ist still way below the real cost of carry and therefore effectively amounts to a real backwardation. Interestingly, the long dated futures do move more with the short term price of oil. For example, when I bought the Dec 2012 contract, it had just fallen nearly $3 as a result of the short term oil price falls. This does not really make sense. The recent short term falls are based on the warm weather in the US. Why whould the weather this month have anything to do whatsoever with the oil price in 2012? But the markets seem irrational here, so this is a buying opportunity.

 

3. Gold. None of the backwardation observed in oil or gas is present in gold futures. Long dated gold futures show a natural contango, increasing with the length of term of the contract, which is in line with the cost of carry. 2012 gold costs over $800.

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Finally, here's a trade idea for those who like to buy UK stocks:

 

BP Plc.

i am just updating my charts, and it looks like the ideal BUY price would be 535-540p,

which is not far away. Some may want to start nibbling at 550p or higher

 

I will put the update chart on the BP thread very soon.

 

at 561p: Yield: 3.74% P/E Ratio: 10.23

 

link: http://www.greenenergyinvestors.com/index.php?showtopic=1028

 

No gtees. DYOR

 

= =

 

GOLD is stuck in contango, because of its monetary characteristic.

You can borrow and lend gold, at low interest rates, and it si easy to transport.

Hence, it will always be in contango (with only very rare and brief exceptions,

if-and-when gold's short dated interest yield spikes.)

 

if you want me to say more about this, let me know

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GOLD is stuck in contango, because of its monetary characteristic.

You can borrow and lend gold, at low interest rates, and it si easy to transport.

Hence, it will always be in contango (with only very rare and brief exceptions,

when it's short dated interest yield spikes.)

if you want me to say more about this, let me know

 

 

That makes sense, but why the backwardation on oil/gas? Does the market really believe that oil will not be higher than $62 by the end of 2012?

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oil cannot easily be used as money, because it is too expensive to transport.

 

thus, oil in one location, can have very different value than oil in another.

 

because gold is used as a store of value (and as money) it is held as physical,

and is constantly in over-supply, relative to its industrial demand.

 

when a commodity like oil, goes into relative shortage, its spot price gets up,

and it goes into backwardation

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The long dated contracts have not fallen as much in the light of the recent drop in short term contracts to $52. Dec 2012 now trading at $59. It's a shame I have used up my ammunition. I reckon NOW is the opportunity of a lifteime, buy Dec 2012 oil under $60.

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Feb 07 crude has fallen by nearly $10 since Dec. 06. The Dec 2012 contract has hardly moved. The gap between the near term contract and the longest out contract has widened to $8. The market clearly does not believe that this drop is anything other than short term.

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fair point.

 

this simply shows there are two markets: short term, and long term,

and they do not always move together.

 

where is the long contract now?

i would be more comfortable buying here, since the spot months

appears to have gone through a climatic selloff now.

 

i bought my bp calls, and they are up about 60%

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Close last Friday was $60.94 on the Dec 2012 crude. I still believe this is a good opportunity. Of course, if there is another commodity sell-off, as Marc Faber predicts, the price could drop another $10 or so, who knows.

 

I think buying this contract has tremendous risk-reward: Oil cannot drop to zero, but let's assume worst case scenario it drops back to $12 where it once was (however unlikely that may be) and stays there until 2012. So at the current price of say $61, your maximum, extreme worst case scenario, loss on this trade is $49,000. A more realistic price that oild could drop back to by 2012 is $30. So your maximum loss is about $30,000. I believe dear Dr. you have risked more than that on far more speculative positions.

 

On the other extreme, if the Saudi Oil fields have a dramatic production drop over the next five years (because they have been overstating their reserves all along), all-out war breaks out in the Middle East, South America gets taken over by communist governments, and Russia descends into a mob-ruled society, then the oil price could go anywhere. More realistically, an oil price of $150 by 2012 does not seem that unrealistic, which would be a $89,000 profit.

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"There will be an initial margin requirement of about $3500, plus any additional margin, should the price of oil fall by more than $3.50 from here."

 

I certainly think oil will be above your purchase price in 2012 but its the "additional margin requirement" that worries me in the above sentence.

If oil falls to $30 you going to have to leave a lot of cash on deposit.

How does that work?

I am correct to assume you get 0% interest and its eaten away by inflation ?

 

Just had another worrying thought, have you had a look at the extraction cost of oil from tar sands etc which are currently uneconomic.

If oil reaches >$100 how many other sources become viable?

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This is an interesting trade however I would also be interested to hear peoples views on how "peak oil" will play out in the wider market e.g.

....should investment be through smaller or large Oil companies (i.e. which sectors, type of oil companies will benefit more from this market change)

...will the higher oil price steadily lift oil shares or will dwindling oil Company capacity and reserves negate a large part of this benefit ?

...how long is it likely that the oil price can be kept at the current level ?

 

Many thanks for any views.

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...will the higher oil price steadily lift oil shares or will dwindling oil Company capacity and reserves negate a large part of this benefit ?

 

eventually, yes, but this is a long way away. Major oil companies will continue to make increasing profits as the oil price goes up, although their profit growth will be limited by the rising cost of extraction. So a pure bet on oil prices will probably yield more. But then again, it is less risky to just buy oil shares like BP, receive the dividends every year.

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chart.gif

 

That usual February dip is when the oil co's run down excess inventories, not needed after the winter,

and when demand falls during "refinery turnarounds" (ie shutting them down for 1-2 weeks and retooling

them to produce gasoline rather than heating oil)

 

Once the february dip is out of the way, crude flies

 

Get some cheap oilies, in these next 2-3 weeks

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I wonder is there a risk with this trade on whether the future contract will last the 12 years?This article on financial sense seems to be saying that the oil market is being moved away from being sold through futures. I'm sure there are other events which would stop oil futures being traded too.

 

So what would happen if the futures market in oil failed for some reason, but oil prices remain high? If I understand correctly you wouldn't end up out of pocket because no money actually changes hands until you close the contract, but you just may not be able to realise any gain.

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There is no riskm from the - totally hypothetical - scenario described in the article as a return to long-term fixed contracts. It does not matter what happens in the future to future contract or whether they will be traded any more or not. Existing contracts are valid and binding, and the NYMEX exchnage is liable for its performance. Only if NYMEX goes out of business might the performance of the contract be in question.

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I am not even bothering to verify or falsify the facts in this "article". The way it is written clearly points to a newsletter selling scam.

 

I could not resist researching anyway. Of course, it is an old story, reheated:

 

http://www.energybulletin.net/11707.html

 

Buried beneath the ground, in Colorado and Utah, are a trillion tons of oil shale. Throughout the 20th century, men have tried and tried again to unlock the energy contained in these rocks. To date, all efforts have failed. But every twenty or thirty years, when energy prices spike, a new attempt is mounted. The persistence is understandable: whoever unlocks this resource would capture a trillion dollar prize. But oil shale?s track record is not encouraging. The rocks are stubborn, an illusive bonanza, promising much, delivering little. Despite a century of trying and $10 billion in investment, oil shale currently provides an infinitesimal 0.0001 (or one ten-thousandth) of world energy. This paper explains why oil shale is so difficult to unlock, and why the ?rock that burns? may never provide more than one percent of U.S. energy.

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Fast forward forward to today and Dec 12 futures contract is $96. Buying one futures contract (1000 barrels of oil) back in Oct 06 would mean you would be up $34,000 less brokerage. Not too bad at all and who knows what the upside could be between now and Dec 12. I would be very suprised to see it fall back to $62.

 

Since I'm a believer in peak oil (or at least a production plateau) I'm looking for a long-term play on oil. I have previously bought oil producers but I'm now looking for a long-term direct exposure to the price of oil. If I believe that oil is going to rise substantially over the next few years then it seems to me that buying long-dated call options is a good strategy. I would buy call options and not futures directly to avoid short-term volatility in the futures price hitting my stop-losses and kicking me out of this long-term trade. I also know what my maximum downside is.

 

From looking at the NYMEX data it looks like the longest dated options is Dec 2010 (although as someone pointed out there maybe other ways of going further out). Let's say I buy an out-of-the-money Dec 2010 call option at a strike price of $120 and the call option price is $7.07 ($7,070). Let's say for arguments sake that oil reaches $150 (this is not being overly optimisitic in my opinion) between now and Dec 2010 so if I bouught a single Dec 2010 call option now I would be up $22,930 less brokerage. If the worst-case scenario happened and oil slumped then I've lost $7,070. If oil were to go really ballistic in the next few years as some analysts say is a distinct possibility then it seems to me that this could be a fantastic trade. To do this trade I really want oil to come back to say $85 and therefore the Dec 2010 call option premium to drop in price significantly but who knows if that's going to happen.

 

For the people who believe in yet higher oil prices in the next few years I don't hear many talking about a futures call option strategy, everyone seems to be talking about buying company stocks of producers or explorers. I'm in Australia so I don't think I have access to a local oil ETF and probably wouldn't be interested in it either. Playing with futures call options rather than stocks means I don't have to worry about stock market sentiment so much or company specific problems.

 

So, what do others think of this idea? I know that trading with long-dated futures is not how most people play futures but it seems like a good idea to me or am I missing something? Remember, I'm betting on higher oil prices in the next few years not the next few months.

 

Greg

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From looking at the NYMEX data it looks like the longest dated options is Dec 2010 (although as someone pointed out there maybe other ways of going further out). Let's say I buy an out-of-the-money Dec 2010 call option at a strike price of $120 and the call option price is $7.07

 

I wouldn't bother with options. They are alos not very liquid.

 

I reckon NOW is the opportunity of a lifteime, buy Dec 2012 oil under $60.

 

Anyway, Dec 2012 oil now at $130. I would like to pat myself on the back and say this thread was the call of the decade. Up $70 since my call, which is $70,000 on one contract.

 

 

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The old oil price model does n't work anymore. It appears the old school or traditional thinkers (expecting price drops) have not adjusted to the new energy pardigm, Peter Schiff has:

 

http://www.financialsense.com/fsu/editoria.../2008/0711.html

 

In these changing times I'm beginning to think the unfettered/inexperienced mind of the novice investor is going to be more of an asset than a hindrance to success.

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I wouldn't bother with options. They are alos not very liquid.

 

 

 

Anyway, Dec 2012 oil now at $130. I would like to pat myself on the back and say this thread was the call of the decade. Up $70 since my call, which is $70,000 on one contract.

Well done BP; I second that pat on the back. I have only just found this thread and have only been active on GEI since Jan. I commend you on picking out this trade back in 06 and I hope you bought more than 1 contract !

 

I too was contemplating buying a long dated contract (somewhere into 2012) a couple of months ago before the move up from around $118. I was waiting for a pull back to $108 which didn't go back as far as I was expecting, and then woosh !

 

My dilema since has been when to get in, feeling the risk of a large correction increasing all the time. For me it is 50:50 whether we get a significant pullback soon or not before reaching $200....

 

I'm intreagued though, how would you view the opportunity now to enter such a trade? Personally, I like Dr Bubbs theory/hope that we get a $15 to $20 pullback with a 2012 target of $400. Oh and allow me, $400 in 2012 will be a cool $340k per contract profit on your Dec 06 price. Very sweet indeed, and of course you have plenty of margin built up already to ride out any short term drops.

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