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Richard Branson: Oil Crunch by 2015. Crude Oil Spreads: Not As Far As We Can See

Sir Richard Branson is predicting that there will be an oil crunch far worse than the credit crunch and it will happen by 2015. “The next five years will see us face another crunch – the oil crunch. This time, we do have the chance to prepare. The challenge is to use that time well.” Branson’s Virgin Group is sensitive to higher prices in energy because they need the fuel.

Sir Richard can use the time well to hedge his exposure. Since his firm Virgin Group needs the fuel, they would be buying hedgers (they are short the physical commodity they need, hence they would buy it synthetically in the futures market – short physical/long futures = hedged postion). They will be enthusiastically grateful to find investors/speculators in the market to take the other side of the trade and to assume the risk. What a hedger gains, the speculator/investor loses.

You can trade crude oil futures all the way out to 2018 on the NYMEX. Right now, the price for Feb 2015 is $86.84. Looking at the spreads, the prices from one contract expiration to the next, you can see that Crude Oil is in what is called a Carry-Charge market – aka a market in contango. Each successive month is slightly more expensive that the next to reflect the cost of carry – costs for storage, shipping, and insurance, for example.

CarryChargeCrude 300x274 Richard Branson: Oil Crunch by 2015. Crude Oil Spreads: Not As Far As We Can See

Crude Oil is a Carry Charge Market (click to enlarge)

Markets in contango tell us that there is ample supply and that anything produced beyond current consumption can be put into storage. You can watch the spreads – they will tell you what is going on in the market like leading indicators. Right now, they are not predicting tightness in crude oil for 2015 as is Sir Richard. To his credit, he is undoubtedly a visionary and he may see things that the rest of us cannot.

My humble guess is he is saber-rattling for the sake of raising awareness for the need for a better global energy policy (especially in the US). I don’t think there is anything wrong with that. But watch the spreads…they will tell you when to trade on Sir Richard’s clairvoyance. And in all seriousness, he may be as good a market prognosticator as anyone else.

Last week, I wrote about the Oil Barges Coming Ashore. In that post, I noted that the crude oil spreads had tightened to the point where there was no substantial upside anymore to holding the physical crude. Therefore, the owners brought crude to market and either delivered against their futures contracts or sold the crude in the spot market. Crude was in contango then too.

Contrast that with the Sugar #11 market which I wrote about recently in the article entitled Prop Traders Can Sit On Their Hands. Sugar #11 is said to be in backwardation: the spot and front months are higher than successive months. Those spreads are telling you that high demand/tight supply are driving the market and that whatever physical you have, bring it to the market immediately. Do not store it.

SugarBackwardation 300x166 Richard Branson: Oil Crunch by 2015. Crude Oil Spreads: Not As Far As We Can See

Sugar #11 is a market in backwardation (click to enlarge)

Not to be out-saber-rattled, the Saudis said in Davos last week “that the situation was overblown.” Former CIA Operative Robert Baer wrote a great paper called The Fall of The House of Saud in the May 2003 The Atlantic Monthly which scared the living contango out of me…and I trade the crude!

The spreads will tell you when and if there is tightness in the supply horizon before most seers can. Spreads will tighten and markets can invert: they can go from carry-charge markets to backwarded markets. Ultimately, you should trust in the price – it tells you everything you need to know.

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 Richard Branson: Oil Crunch by 2015. Crude Oil Spreads: Not As Far As We Can See

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  • Bend

    In hedging their exposure 5 years from, would buying a future so far out be much more expensive than buying a nearer horizon future (as would be the case for an equity option)?

  • martinkronicle

    Yes, if Virgin used commodity futures, there would be that much more
    carry charges. There is no time decay though.

  • Bend

    In hedging their exposure 5 years from, would buying a future so far out be much more expensive than buying a nearer horizon future (as would be the case for an equity option)?

  • martinkronicle

    Yes, if Virgin used commodity futures, there would be that much more
    carry charges. There is no time decay though.

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