Last night the July NYMEX crude oil/natural gas spread expired at 1.702, i.e. 1 WTI contract could purchase 1.702 contracts of Henry Hub natural gas. From a historical point of view, that is wide. But, as we discussed in yesterday’s issue of The Schork Report, owing to an underlying fundamental shift peculiar to each one of these markets, we might have to discard our understanding as to what is a “normal” relationship between oil and gas on the NYMEX.
In early April, Marc Clark, Director of Marketing at Allied Energy, Inc., challenged our call on market direction, stating “…oil price is not based upon real market metrics, price is determined by speculation, and speculation is based upon perception and rumor. Oil price will see $60 before it sees $40 again. Heating oil and natural gas will see a seasonal dip reflecting true metrics, but the same doesn’t apply to oil.”
In this time period, heating oil has rallied 21% and natural gas has remained effectively unchanged. Still, it was a good call on oil, Marc – starting at $43.83 on April 21, it was virtually a straight shot up to a high of $73.23 on June 11. While we maintain that the fundamentals do not justify this run, Keynes said it best, “Markets can remain illogical for longer than you can remain solvent.”
As we hash through the post mortem of this trade (how else are we going to learn?), one thing is certain, the market did not know whether this spread was mean reverting or not. If it had been, we could’ve expected some measure of convergence, but it obviously did not revert for July. Thus, with that fundamental property voided there was no amount of high level analysis they could produce a desirable result as we look ahead to the nearby spreads.
As we noted at the time, historical data for this spread suggested a lack of statistical correlation and the market moved independently from year to year. Therefore, fundamentals were defining the relationship between these two markets. As far as we were concerned, the fundamentals for both markets were poor. What’s more, given crude oil’s rapid rise up until that point, we felt the fundamentals weighed against oil.
We failed to appreciate the degree to which exogenous market fluctuations for crude oil (geopolitics, dollar value and politically savvy euphemisms, i.e. “green shoots”) could perpetuate the rally. As such, crude oil continued to rally, but not gas. Therefore, the spread continued to widen.
However, exuberance in the crude oil market is waning.
In other words, telltales appear that a correction in crude oil is imminent. Over the last week we have received a number a queries regarding the impact of the ongoing civil unrest in Iranto crude oil prices. Our response has been… it has yet to matter. Spot August WTI is off 8% from recent highs, despite the headlines from Iran. Is this a case of good news/bad action? It certainly smells that way.
That is to say, the bullish trend in crude oil has failed to perpetuate despite the introduction of bullish headlines from Iran… or Nigeria for that matter. Crude oil’s rapid rise has stalled. This is not how a “bull market” responds to evidence of an incipient revolution and the violent suppression of that revolution inside a country that sits atop 1 out of 10 barrels of the world’s proven reserve of oil.
A market that cannot move higher on news like that appears ripe for a further selloff. In this vein, here at we will be looking at how crude oil responds to tomorrow’s FOMC federal funds decision. Expectations are the minutes from the Fed’s meeting will spur further dollar weakness. If this does indeed occur… and, crude oil does not respond, i.e. strengthen against the dollar weakness, then we will have further good news/bad action confirmation that the rally in oil has run its course.
Stephen Schork is the Editor of, and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.