March 28, 2006
CRUDE FOR THE MASSES. WILL THEY BITE? SHOULD THEY?
The first oil ETF is almost here.
The Wall Street Journal (subscription required) today reports that the American Stock Exchange will launch a crude oil fund next Monday, with the symbol USO. (For a copy of the SEC filing, click here.) Another milestone in the world ETFs, which trade on exchanges like stocks.
Once the ETF is trading, investors will be able to buy direct exposure to crude oil futures contracts via a listed security for the first time. The question, of course, is whether there's a compelling case for buying oil futures at this juncture.
Leave it to Wall Street to come out with a product after the price of oil has been climbing for the better part of nine years. That, of course, is the way the financial system works. When oil was languishing at just over $10 a barrel in late 1998, the idea of oil-related investment products was the financial equivalent of leprosy. Today, in the wake of a near five-fold climb in the price of crude from late-1998, the Street can't talk enough about of the opportunities in energy. Indeed, there are any number of hedge funds dedicated to energy plying the markets that were mere ideas a few years back.
To be fair, the SEC probably wouldn't have approved a publicly registered oil ETF in 1998. Then again, it probably wouldn't have mattered if the regulators ok'd the idea. New-product launches tend to reflect the investment du jour, or hadn't you noticed? Remember internet-equity mutual funds?
No, oil's not tech. That is, oil's no fly-by-night investment gimmick. Even so, you can lose lots of money in crude, or turn a tidy profit. But after watching a barrel's price climb almost steadily in recent years, one has to wonder when the show will take a breather.
Yes, we're second to none in recognizing the case for a long-term bull market in oil. Indeed, we've penned more than a few articles on the subject over the years, as regular readers of CS know. But at this juncture, in the here and now, the question is whether jumping on the bandwagon is enlightened or something less? Ergo, is the emotion that's likely to dominant for the foreseeable future in oil pricing A) Greed, or B) Fear?
To gauge an answer, we looked at the latest data from the Energy Information Administration, on the perhaps naive assumption that supply and demand trends can shed light on prices going forward. On that note, there are several reasons to be cautious. Exhibit A is the stocks of crude oil. As the graph below shows (courtesy of EIA), supplies of oil in the U.S. refinery system have been running above average recently, which casts a short-term bearish pall over prices.
Meanwhile, EIA's short-term projection for oil predicts an average price of $61 next year, down from the expected $64 average price per barrel for 2006. In fact, $64 a barrel just happens to be the current price of oil, based on last night's close in New York futures trading.
Then again, Mr. Market has his own ideas about what comes next. The October 2006 crude oil contract traded on NYMEX is priced for a $67 a barrel.
There are as many guesses about where oil's headed as there are rigs in the Middle East. The past, at least, is clear. With that in mind, it's a safe bet that the robust state of the U.S. economy has been front and center in keeping oil prices buoyant in recent years. U.S. GDP climbed by an annualized range of 3% to 4% last year, based on quarterly numbers. But expectations for something slower are percolating through the punditry system. If so, a material slowdown in the economic expansion in 2006 and 2007, as EIA and others expect, is likely to put downward pressure on oil prices.
With that in mind, the best guess for where oil prices are headed may come from reading the tea leaves on the economy. As it happens, that's a timely bit of advice, given this afternoon's announcement from the Fed on interest rates. The central bank may not have much influence on the price of oil, but it has the capacity to squeeze the economy, which may be the next best thing. Thus the question: Is the central bank still intent on slowing the economy? If so, what does that imply for oil prices in the land where the thirst for petroleum is second to none?
Of course, all the enlightened analysis in the world isn't worth a nickel in the wake of an "event." Oil, afterall, is more than just another commodity, and so its price reflects geopolitical as well as economic risk. Modeling oil prices, in other words, doesn't work all that well, at least compared to corn or lead.
© 2006 by James Picerno
Posted by jp at March 28, 2006 9:50 AM
Leave it to Wall Street indeed. Sometimes market tops are writ large across the sky. The day after they opened the new trading floor for CBOT financial futures, the fed stopped issuing 30 yr bonds. I always figured we'd see some stories about airlines finally having to reckon with hedging their fuel risk at >$30 as the top. Back when oil was 12, they were talking about how every dollar per barrel was like 100 Mil off the bottom line.
Posted by: jf at March 28, 2006 9:41 PM