Oil traders are paying more than ever in the options market to protect against a plunge in crude prices.
The gap between prices of options betting on a decline and those that would profit from a rise in oil widened to a record 10 percentage points, according to five years of data compiled by Banc of America Securities-Merrill Lynch. Crude stockpiles in the U.S. are 14 percent larger than a year ago and OPEC is pumping 600,000 barrels a day more than the world needs, according to the International Energy Agency.
While the recovery from the first global recession since World War II pushed oil up 62 percent this year to $72.04 a barrel in New York, growth alone isn’t likely to erode the glut by the end of next year because production exceeds demand, data from the Paris-based IEA shows. A drop in prices would penalize companies from Exxon Mobil Corp. to BP Plc and exporters Russia and Saudi Arabia.
“If ever there was going to be a retreat below $60 a barrel, it is now,” Stephen Schork, president of consultant Schork Group Inc. in Villanova, Pennsylvania, said in a telephone interview. “It was a very weak summer. We came out with more gasoline than we started.”
Right to Sell
Options granting the right to sell, or put, oil in December below current prices have a so-called implied volatility of 54.3 percent, compared with 43.3 percent for the equivalent options to buy, or call, data from the New York Mercantile Exchange show.
The premium for December and other put options shows “the market is worried,” said Harry Tchilinguirian, a senior oil analyst at BNP Paribas SA in London. “If puts are pricing higher than calls, we are looking at a situation where the market is more averse to the downside and is looking for more compensation” for the option, he said.
Demand for puts may be caused by speculators betting on lower prices or by producers hedging against a decline in the value of their oil, Tchilinguirian said.
Oil inventories totaled about 2.8 billion barrels at the end of July within the 30 nations of the Organization for Economic Cooperation and Development, according to the IEA. The total is equal to 62 days of demand, and 4.6 percent more than the same time last year.
Supplies are brimming on both sides of the Atlantic. U.S. distillate fuel inventories, which include heating oil and jet fuel, are the highest since 1983 at 167.8 million barrels, according to the Energy Department. U.S. gasoline supplies are 2.2 percent greater than they were in late May, the start of the peak-demand summer driving season, at 207.7 million barrels.
Gasoil stockpiles, the European equivalent of heating oil, near Europe’s refining hub of Rotterdam reached a record 3.03 million tons (23 million barrels) on Sept. 10, according to PJK International BV of Oosterhout, the Netherlands.
More than 60 million barrels of fuel is stored on tankers offshore, according to the IEA.
“There’s all this heating oil with no place to go,” Philip Verleger, a professor at the University of Calgary and head of consultant PKVerleger LLC, said in a phone interview. “I’m fairly certain we’ll see prices in the $30s this year.”
Crude rose as high as $75 a barrel on Aug. 25 as government spending to revive growth spurred demand around the world. Oil for October delivery slumped as much as $2.94, 4.3 percent, today to $68.96 a barrel on the New York Mercantile Exchange.
Gross domestic product in the U.S., the world’s biggest energy consumer, will expand by 2.4 percent in 2010, after shrinking 2.6 percent this year, according to the median estimate of 57 forecasters surveyed by Bloomberg.
Saudi Arabia’s oil minister said stockpiles have become irrelevant to crude prices because of the rebound.
“Economic growth is the name of the game,” Ali al-Naimi told reporters in Vienna on Sept. 9 before a meeting of the Organization of Petroleum Exporting Countries. “Oil today is a commodity. As long as economic growth is there, the price is going to go up.”
Traders are betting with al-Naimi. Hedge-fund managers and other large speculators increased their net-long position in New York crude-oil futures 38 percent in the week ended Sept. 15 to 45,557 contracts, according to U.S. Commodity Futures Trading Commission data.
OPEC, whose members supply about a 40 percent of the world’s oil, agreed at the meeting in Vienna to maintain current production quotas and eliminate surplus production.
The group pumped 1.2 million barrels a day above its target of 24.845 million barrels a day in August, according to Bloomberg estimates, and more is on the way. The group will increase shipments by almost 1 percent this month, according to Halifax, England-based consultant Oil Movements.
Kuwait’s OPEC delegate, Mohammed al-Shatti, said Sept. 17 a “small” reduction in output will be needed next year because of lower demand. The group agreed to record production cuts of 4.2 million barrels a day through December of last year.
Stockpiles would need to shrink by almost 1.1 million barrels a day in the OECD, close to the combined production of OPEC members Qatar and Ecuador, to get inventories to OPEC’s targeted levels a year from now, IEA data show.
The glut will cut demand at refiners from Valero Energy Corp. to Total SA as the seasonal peak in consumption approaches. The profit from turning West Texas Intermediate crude into gasoline and heating oil fell last week to $3.42 a barrel, the lowest since December. Plants in the U.S. and Europe are being idled.
San Antonio, Texas-based Valero, the largest U.S. refiner, shut its plant in Aruba and is idling operations in Delaware City, Delaware. France’s Total, Repsol YPF SA of Madrid and Zug, Switzerland-based Petroplus Holdings AG have switched off refinery units in Europe.
“Combined refining margins for gasoline and heating oil have fallen to their lowest level since 2000 and refiners are going to respond by cutting runs, and cutting back on crude purchases,” said Verleger, a former U.S. Treasury adviser.
While Verleger has dropped a forecast made in July that oil would sink to $20 a barrel, traders are anticipating a decline. The Nymex’s most popular option is the right to sell December crude at $60 a barrel, with 69,244 contracts outstanding, exchange data show. The right to sell at $50 a barrel is the second most widely held. The December 60 put option rose today 47 percent to $1.66.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.