On Aug 24, 2006, at 5:52 PM, raghu wrote:
The EIA releases those numbers for the US every week <http://
tonto.eia.doe.gov/dnav/pet/pet_sum_sndw_dcus_nus_w.htm>. There are
over 1.7 billion barrels of crude & products in inventory. The
markets take these weekly releases seriously. So it's not magical
neoclassical assumptions.
I beg to disagree. The DOE link you pointed to does provide
statistics on crude and gasoline stocks. What it does NOT provide
is some indication of the costs of storage. Also how much of this
storage belongs to the Strategic Petroleum Reserve (which
presumably is not available for arbitrage purposes).
The SPR numbers are there.
The arbitrage argument outlined so elegantly by the NYT assumes
away any such pesky costs. And that such arbitrage can be
implemented instantaneously. This is indeed "neo-classical magic".
You claim that "The
markets take these weekly releases seriously." Your faith in the
wisdom of the financial markets is touching,
Wisdom? Heavens no. My point was that stock levels contribute to
price setting, and that those levels move around a lot.
but can you elaborate how one can make sense of the recent oil
price movements using this data? The futures price (the benchmark 1
month delivery contract) jumped after BP announced its Prudhoe
closure on anticipation of shortages in the future but why did the
spot price move so rapidly?
Why not? Thousands of traders moved on the news.
The type of "storage arbitrage" implied by the NYT surely requires
some time to implement, even if it is costless?
Not when you've got derivatives markets.
In other words it was not actually necessary to implement the
arbitrage but only necessary that a consensus existed among all the
participants that such arbitrage was possible. A consensus that
would lead to convergence between spot and futures prices in a case
of self-fulfilling prophesies. Of course if as the NYT article
says, the consensus now believes that "storage units are close to
capacity" the market presumably would move in response to that
consensus. But all these moves are based on belief not actual
physical arbitrage. Which is what I meant by neo-classical magic.
There's nothing neoclassical about it - prices move almost
instantaneously according to changes in expectations. Keynes wouldn't
have argued the point.
<http://www.eia.doe.gov/oiaf/servicerpt/derivative/chapter3.html>
Calendar Spread Options
Storage facilities play an important role in the crude oil and
refining supply chain. Facilities near producing fields allow the
producers to store crude oil temporarily until it is transported to
market. Facilities at or near refining sites allow refiners to store
crude oil and refined products. Heating oil dealers build inventories
during the summer and fall for winter delivery. Natural gas storage
facilities allow producers to inject excess supply during “shoulder
months” for withdrawal during peak demand months and provide
producers with the convenience of a shortened injection and
withdrawal cycle (a day or a few days), giving the producers and
traders the ability to capitalize on the differential between forward
prices and spot prices.
For most non-energy commodities, the cost of storage is one of the
key determinants of the differential between current and future
prices. Although storage plays a smaller role in price determination
in some energy markets (most notably, for electricity), it can be
important for heating oil and natural gas.35 For example, natural gas
prices in the winter months could be established by the prices in the
preceding shoulder months plus storage expenses and an uncertainty
premium to account for the possibility of a colder than normal
winter. If the price differential between winter months and shoulder
months substantially exceeds storage expenses, traders can buy and
store gas and sell gas futures. Such arbitrage tends to narrow the
price differential.
The owners of storage facilities can use excess capacity both to
manage the price risk that often exists between months and to make
additional income. Assuming the market is in contango—i.e., when near-
term prices (for “prompt months” are lower than prices for the months
further in the future—owners of underground natural gas storage
facilities with excess capacity that can be used to store natural gas
for less than the difference between the prices can purchase futures
contracts for the prompt months and sell futures contracts for the
further future months. The storage facility can then take delivery of
the natural gas on the nearby contract and deliver it against the
distant contract, earning an arbitrage profit equal to the difference
between the sale and purchase of the futures contracts less the
facility’s cost of storage.
Such arbitrage can also be accomplished by using a calendar spread
call option. NYMEX offers calendar spread options on crude oil,
heating oil, and unleaded gasoline. Buying a call on the calendar
spread options contract will represent a long position (purchase) in
the prompt months of the futures contract and a short position (sale)
in the further months of the contract. Thus, the storage facility can
buy a call on a calendar spread that will allow it to lock in a
storage profit or to arbitrage a spread that is larger than its cost
of storage.
If the market is in backwardation—i.e., when the prices for prompt
months are higher than the prices for further months—storage
facilities with excess capacity cannot arbitrage the calendar spread.
In this case, storage facilities can sell put options on calendar
spreads to earn income from the option premium. The buyer of a
calendar spread put option, when the option is exercised, will
receive a short position (sale) in the prompt months of the futures
contract and a long position (purchase) in the further months of the
contract. Thus, if the storage facility that sold (wrote) the put
option is forced to accept delivery because the buyer has exercised
the option, it will receive a long position in the prompt futures and
a short position in the further futures. If the facility has excess
storage capacity, however, it can take delivery on the prompt
contract and then deliver on the later dated contract. If the put
option is not exercised, the facility can keep the option premium
without any further obligation. In summary, storage facilities can
use futures contracts and calendar spread options to optimize
utilization by arbitraging the difference in the prices specified for
different months of a futures contract.
