Phew! Futures indicate that the oil spike won’t last
Syria concerns have driven crude oil to a two-year high. But the futures market is telling traders that a correction could come soon.
As the U.S. appeared to draw closer to a military strike against Syria, oil closed Wednesday at its highest level since May 2010. But while crude oil for October delivery closed at $109.52, crude for December delivery settled at $107.32, and crude for June 2014 delivery closed at $99.47, gaining just 2 cents on the day.
So what's going on here?
Well, it's important to understand that there's a great deal of complexity to the market
"We cannot say, 'Aha! The market is going to trade at this given level,'" said Stephen Schork of the Schork Report. In fact, this situation indicates that "the market is pricing in some sort of value for owning barrels in the spot market," and for that reason is a testament to the strength of the oil market.
The shape of the futures curve "is a very bullish metric in the short term. It means there is either not enough supply, or too much demand," Schork told CNBC.com. With oil at $110, "if I can take oil, put it in a tank, and sell it a year from now at $100, why would I want to do that?" Schork said. "Refineries are paying a premium because they need that barrel now."
But on the other hand, "we'll pull more inventory out of the tank and put it into the spot market," Schork said. "Eventually, this will lead to a pullback in prices."
So why is the market providing such a discount for further-dated contracts in the first place? The situation's very name, "backwardation," indicates its oddness.
"This summer, we had very strong demand and a very sharp drop in inventory levels, so we got very steep backwardation. And headline risk is exacerbating it," Schork said.
(Read more: Why the Syrian crisis will mean higher gas prices)
As CNBC "Futures Now" contributor Anthony Grisanti put it, "Traders are worried that in the near term, the supply of crude oil will be affected" by the situation in Syria. While Syria does not export oil, a broader conflict that involves major oil producers like Syrian ally Iran could lead to serious supply issues.
"Fundamentally, there's plenty of crude oil out there," Grisanti said. "If none of this was going on, we'd be trading closer to $100, and the market was aware of that. So they're pricing in all the uncertainty in the front month."
How, then, does one profit off of this situation?
"Maybe the ultimate trade is to sell that front month and buy the back," Grisanti said. If any Syrian military action "turns out to be quick and dirty, and you see no response from Russia or anybody else, oil is going down."
(Vote in our poll: Where will crude oil end the year?)
"We have had a huge increase in domestic production. We're seeing demand change for Americans as we try to focus on alternative energy, and we have geopolitical issues out front," Kilburg said. When it comes to backwardation, "Is there more room to stretch this rubber band? Yes."
For his part, Schork said "you can't sell this market yet." After all, "higher prices are now the justification for higher prices, and you have the greed element pushing prices higher and higher."
Still, he believes that crude oil is about to provide a perfect example of "why markets fall faster than they rise. That's certainly the scenario we're building up right now. The question is, do we fall from $115, $125, or $150?"
Schork added: "We'll just have to wait and see when we get that breaking point."