Rising crude prices reflect belief recovery underway

Almost immediately after the generally warm response from the Muslim world to US President Obama's Cairo speech was registered by traders, crude benchmark prices shot up. In New York, the benchmark West Texas Intermediate light sweet started on Thursday at $66.09 per barrel and ended the day at $68.81 per barrel.

This quantifies the extent to which residual concern over East-West geopolitics is affecting oil markets. While the dollar also gained marginally against other currencies over the last few trading days, such small gain could not explain a more than $2.00 per barrel gain on the day of Obama's speech.

The futures curve plotting crude benchmark delivery months on the horizontal and crude price per barrel on the vertical is becoming more contango, with farther back delivery months increasing in price against the nearbys.

Nymex crude delivery for June 2012 is $81.24 per barrel, a significant increase over the $73.28 per barrel price on May 27. While the farthest back delivery months are not much higher than the medium-term delivery months, it is clear that market participants are becoming convinced that, at least for commodity markets, recovery is underway.

Commodity prices are a leading indicator of economic activity since they will be needed before any intermediate or finished goods can be produced. If markets are increasing their demand for commodities, it signals that more production in the near future is planned.

The local Dubai Mercantile Exchange's benchmark Oman heavy sour closed Thursday at $68.73 per barrel, a strong gain over the previous week's close of $64.67. In the last two weeks, Oman has gained $8.58 per barrel. New York heating oil nearby futures, the chosen hedging vehicle for all middle distillates and transport fuels, finished the week at $1.77 per gallon, strongly up from last week's $1.67 per gallon. In two weeks it has gained over $0.20 per gallon.

Last week's Commitments of Traders report from the US Commodity Futures Trading Commission showed increasing futures contracts in effect over last week. Commercial hedgers, who represent around 65 per cent of all futures and options on futures contracts in effect (open interest) are afraid crude prices have risen too fast in too short a time and are hedging against the expected price retrenchment. The Chicago Board Options Exchange's OVX index of price volatility for crude on the Nymex closed the week at 46.75, up from the previous week's Friday close at 41.32. With prices gaining so much during the week, it is natural for the volatility index, which registers any increase demand for options on futures, to gain.

Commentators last week discussed the large differential between crude oil and natural gas prices in the North American market, pointing out that natural gas has not been this cheap relative to crude oil in decades. But this is not an indication that natural gas is likely to rise near term. The reason is that so much new supply has been discovered in North America that natural gas prices are likely to remain depressed, at least in North American markets, for the near future.

- Dalton Garis is associate professor of economics and petroleum market behaviour at the Petroleum Institute, in Abu Dhabi.