It has been less than three weeks since the DOE issued its Short Term Energy Outlook (STEO) for October, but prices moved further in those three weeks than they have in the past three months. For instance, October was the first month in which the DOE released confidence intervals for the major commodity contracts.
The two CI’s (95% and 68%) were meant to demonstrate the confidence with which we could expect prices to trade within a certain band. But in three short weeks oil prices have increased to such a degree that the DOE’s STEO prices are already touching the lower confidence interval – that is, we can now be 68% sure that the December contract’s prices will be higher than the DOE’s original forecasts.
For instance, the DOE’s lower 68% confidence interval on October 1st for the December contract was $57.69. The current lower bound for the same contract is $70.43. Further out, the April 2010 contract had an expected 68% confidence interval of ($51.77, $96.30), now it’s shifted upwards to ($63.54, $108.18). Overall, the upper bound has increased from an average of $99.73 to $112.21 (See Chart of the Day in today’s issue of ).
Due to the strong upward motion, prices have become slightly less volatile. The implied volatility, that is the volatility implied by working backwards from an option pricing model such as Black Scholes, has decreased from an average of 44.4% to 41.5% over the next 14 months.
An interesting corollary is the extreme December 2010 contract, which on October 1st had an upper bound of $112.29, 1.29% higher than the November 2010. Today however, the Dec ’10 upper bound is $126.15, still high but now only 0.05% higher than the Nov ’10 CI.
Bottom line, prices have shifted substantially higher since the DOE issued its October STEO. The extant glut of crude oil around the globe notwithstanding, there is still space for a decline below the $70 level, but it is probabilistically much less viable now than it was three weeks ago.
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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.