Crude futures show prices may have hit bottom

Abu Dhabi: With continued declining resource sales and demand in the world economy, last week's March futures crude contract in New York, gaining strongly by week's end, was a trader vote that crude prices have hit bottom.

We have also seen DME Oman and the ICE's Middle East sour contracts trading higher than New York's nearby light sweet, until Thursday, when local market sours adjusted downward on China's released lowered GDP figures, and on Japan's further warnings of worse econ-omic news to come.

The February contract expired this past week and its gyrating price reflects expiration activity as sellers and buyers closed out their positions.

The March contract is therefore a better reflection of prices as traders rolled their positions over into March, allowing this new front month to accurately reflect futures demand for hedging and speculating. After reaching around $40.00 per barrel (Dh146.94) the March contract ended the week at $46.47 per barrel, strongly up from the previous week.

The Chicago Board Options Exchange index of crude price volatility, the OVX, continued to register high numbers, above 80. But some of the recent volatility must be blamed on the February month expiration.

Over the next few days expect this to fall back into the 70s or below. The recent Commitment of Traders report from the US Commodity Futures Trading Commission indicates that commercials are increasingly balancing long and short positions, possibly indicating that crude prices are not expected to rise much further near term. Commercials are voting that crude will trade in a range between $39.00 and $45.00.

Recently, clients with the necessary cash have been leasing crude tankers (VLCCs), topping them up and parking them offshore waiting future eventualities.

A look at the farther back futures contracts provides the explanation: All the back months are strongly higher than the nearbys.

The DME's 2010 January contract is $54.46; and the January 2012 contract is $64.13. Thus, were it not for the increased cash purchases for future hedging and to top up national strategic reserves oil prices would likely be lower than at present.

Is the New York Mercantile Exchange's benchmark light sweet West Texas Intermediate still relevant? Probably not. It is a landlocked crude with limited to no international market exposure. It therefore is a poor metric of crude oil's marginal values.

Far better are the sour benchmarks, such as ICE's Middle East sour or the Dubai Mercantile Exchange's Oman sour. Indeed, their price steadiness is in sharp contrast to WTI's recent gyrations.

New York natural gas continues to weaken. In spite of North American weather being colder than average so far, the decline in industrial and commercial demand has continued to force natural gas prices down.

Last week, the Nymex nearby natural gas contract ended at $4.50 per million Btu. It hasn't been this low since January 2004.

- Dalton Garis is Associate Professor of Economics and petroleum market behaviour at the Petroleum Institute, in Abu Dhabi.