BNP Paribas’ Harry Tchilinguirian has put out a very interesting oil note on Wednesday.
First, the bank has revised its fourth quarter 2009 WTI price forecast to $77 per barrel versus $66 per barrel previously, due to ongoing USD weakness and low interest rates.
Second, the bank believes the market will soon be forced to price in the weak fundamental picture it’s so far been avoiding with a sharp steepening of the WTI contango.
As to how the contango manifests itself — whether via a near-term sell-off in front month futures or a spike in longer-dated prices –Tchilinguirian suggests at this stage it’s anyone’s guess (our emphasis):
In the short term, there remains a great deal of uncertainty as to where the flat price may end up. Oil is likely to trade in a wide range over the next 3 to 6 months, possibly $65 to $85/Bbl. However, if weakness in the short-run fundamentals is not reflected in the flat price, the shape of the forward curve will still need to accommodate the underlying physical reality.
So if we do have a growing surplus in crude oil or products, as a result of the combination of a weaker than expected pace of economic recovery in advanced economies heading into 2010 and positive supply surprises, the nearby time spreads on the forward curve will need to change. Either the front price will need to weaken for someone to lift the oil, or the forward price has to rise to offset the cost of carrying oil forward in inventories, be it on on land or in floating storage, until such time demand can absorb the excess supply.
Either way, the contango will have to widen rather than narrow, delaying prospects for backwardation for the second half of 2010 when economic growth will be stronger, oil inventories lower and OPEC spare production capacity reduced.
Whatever the case, it’s clear commodity investors are becoming increasingly risk averse to the idea of a sell-off, says Tchilinguirian.
As he notes, open interest on $60 strike-price WTI put options for January 2010 has risen considerably:
…open interest on the NYMEX floor for January 2010 delivery for USD 60/Bbl strikes reached 37,981 by 16 November. In terms of volatility, the skew between 25 delta puts and calls is still heavily titled in favour of out of the money puts for Dec’09, Jan’10, Feb’10, and Mar’10. One can argue relative dynamics of supply and demand for options at this strike level as means of explanation. But for a market that appears bullish, higher premium for puts over calls also reflect, to some degree, increased risk aversion towards a potential price correction.
This is reflected in the following chart:
Goldman warns of near-term downside risk in WTI – FT Alphaville