Note this dramatic headline isn’t quite as dramatic as it appears. The ten-fold increase in $200 one year Nymex WTI oil options is in open interest, meaning the number of contracts outstanding, not their price (their price increased a mere 36% in a month). And the reason for their popularity? A seriously out-of-the-money option is the cheapest and most levered way to play a point of view.
So the increase in open interest indicates a strong appetite for betting on further oil price appreciation. That alone might point to oil being currently overbought and subject to an intermediate price decline, particularly if other major economies start to look weak. However, oil mavens say inventories are extremely tight.
The fastest-growing bet in the oil market these days is that the price of crude will double to $200 a barrel by the end of the year.
Options to buy oil for $200 on the New York Mercantile Exchange rose 10-fold in the past two months to 5,533 contracts, a record increase for any similar period. The contracts, the cheapest way to speculate in energy markets, appreciated 36 percent since early December as crude futures reached a record $100.09 on Jan. 3.
While analysts at Merrill Lynch & Co. and UBS AG say the slowing U.S. economy will lead to the biggest drop in prices since 2001, the options show some traders expect oil to rise for a seventh straight year. Demand will increase 2.5 percent in 2008, according to the International Energy Agency. U.S. inventories fell to a three-year low on Dec. 28. Production from Mexico is declining and Saudi Arabia is behind schedule in opening its newest field.
“One hundred dollars a barrel is actually 14.9 cents a cup, so we’re still talking about oil being remarkably cheap,” said Matthew R. Simmons, chairman of Simmons & Co. International, a Houston-based investment bank that focuses on energy. Inventories“are tight as a drum and I don’t see how we get out of this box,” he said in a Bloomberg television interview last week. “Demand clearly isn’t starting to slow down.”
World consumption will rise to 87.8 million barrels a day this year, 2.1 million more than in 2007, or about the same amount that Nigeria supplies, according to the Paris-based IEA, an adviser to oil-consuming nations. Demand from China alone will increase 5.7 percent to 8 million barrels a day as imports expand to support an economy that’s likely to grow 11 percent, the IEA said.
Oil suppliers are straining to increase production. Saudi Arabia, the world’s largest exporter, said last week that the 500,000 barrel-a-day Khursaniyah oilfield missed a December start date. Brazil’s Tupi field, the second-largest find of the past two decades, lies more than eight kilometers (five miles) below the ocean surface and will take at least five years to develop.
Petroleos Mexicanos, Mexico’s state oil monopoly, suffered a three-year, 40 percent decline at its Cantarell field, the world’s third-largest. Fighting in Nigeria reduced production 11 percent since December 2005 to 2.18 million barrels a day, according to data compiled by Bloomberg….
The Nymex options, which give speculators the right to buy 1,000 barrels of oil in December, are becoming a favorite for traders even if they don’t expect crude to reach $200 because they are a cheaper way to speculate than using futures contracts. Options expire worthless if crude fails to reach the “strike” price. There were 500 of the options on Nov. 7…..
Oil forecasters say there’s no chance of $200 crude, as the U.S., which consumes a quarter of the world’s oil, slows. Prices will average $78 a barrel this year, 20 percent below the current level, and $75 in the fourth quarter, according to the median forecast of 27 analysts surveyed by Bloomberg. The last time prices fell that much was in 2001, when they dropped 26 percent.
The greater fool theory rides again, it would seem.