The rise, plus confirmation that the Fed is now on hold so far as rate cuts is concerned, sent Wall Street down for a second day: the loss so far around 3% on the Dow and over 2% for other indices. The surging oil price remains the big driver. Usually oil and other commodities are in what the commodity experts call "backwardation". That's when the out year prices (about longer than a year) are lower than the spot or current futures month contract.
So, if oil is trading around $US129 a barrel, as it is now, then the contract for September 2009 will be lower, and November, lower still. It's a signal that high immediate prices will bring greater supply or cause demand to fall so that an oversupply situation develops. But if the out year prices are higher than the current price, that's known as 'contango' and a sign of tight supply or an impending contraction in supplies.
So then what are we to make of the current oil market where the 'out years' up to 2016 have seen prices rise 60% so far this year, compared to a 35% rise in the current price? Is it madness, or a sign of greater forces at work in the market? Some would say its speculators and a bit of froth, others would say there are several factors at work which relate to the overall market for energy: coal and gas, not just oil. China is part of the answer: its strong continuing growth and the big earthquake last week.
Overnight Tuesday in world markets, nervous buyers(speculative and trade) emerged to trade oil four and eight years out from now: i.e. oil was bought and sold for delivery in 2012 and 2016; as well as sending the most immediate price to a new high of $129.60 a barrel. The price for 2016 was $US139.30 a barrel: which is madness considered what could happen between now and then, or an absolute steal. That rose to $US142.09 Wednesday night.
The surge in trading in the out years (not the 'out months" as futures traders usually refer to forward contracts away from the spot or the most immediate contract) was dramatic and unheard off according to traders quoted in the Financial Times and other media. It led to a surge in oil to a new high of $US129.60, meaning the price has leapt from around $US100 a month in less than four months, and is now well over double what it was a year ago. It seems a bubble that is enveloping the world, quickly.
But unlike the explosion of the easy money/credit boom, the pricking of the oil bubble will be welcomed the world over, except in the next basket cases like Venezuela, Nigeria, Mexico, Russia and all those oil rich countries wasting their new found wealth, and by other energy exporters, like Canada, South Africa, Indonesia, and Australia. The rapid rise in oil prices is bringing pain, as well as pleasure to many countries, boosting inflation in the US, Europe, Australia, New Zealand and everywhere.
It's also boosting national income in a way not seen for decades, with Norway, Australia and Canada among the major beneficiaries because of the mix of their exports and the way the boom in commodity prices is boosting export income faster than import prices can rise: i.e. our terms of trade are improving rapidly. But there is more to run for various reasons.
Take coal prices, already boosted by China's withdrawal from the world market because of the severe weather in January and February left it short of coal. Last week's big earthquake has left the country even shorter of coal, oil, gas and nuclear power.
A total of 32 power plants have had to be closed in China for fears of damage from the quake. That has meant more power has to be generated elsewhere in the country from coal, oil, gas and nuclear stations, meaning China will not be able to export any coal for some time. And news this week from South Africa that the biggest supplier of thermal coal to Europe might start cutting exports to help rebuild dangerously low supplies at the country's power monopoly. This is only a plan, but it is forcing up the cost of thermal coal on world markets.
Export coal prices for this year are already doubled and trebled in some cases for coking and thermal coal: the latest news from China and South Africa will see spot prices remain high and get analysts wondering about the current level spillover into the 2010 year. And that will infect the oil market, while the continuing surge in oil prices will drag the prices of other fuels higher. For example, ethanol prices will rise, as will the price of biodiesel.
And, the Chinese quake will also mean the country lifts its purchases of diesel fuel to burn in mobile generators which have been sent to the earthquake zone in their hundreds: that boosted the price of heavier oil products, such as home heating oil on the US market. This is in addition to the rising level of demand from China for oil and other energy forms: the quake will mean those demands are increased noticeably for an indefinite period of time. All this is helping support the surging oil market which has now decoupled from other commodity markets.
Then we will get another 'oil shock' and it will be just as nasty as the one we are feeling know from petrol and diesel prices rising by the week.
