Schork Oil Outlook: It is Starting to Get Interesting

Yesterday analysts at The Schork Reportexamined the DOE’s confidence intervals (CIs) for the crude contracts for 2010. We found the DOE’s predictions to be low given the market’s sudden bullish sentiment, as evidenced by prices on Friday being at their highest annual levels.

Today we examine natural gas contracts with the difference being the inclusion of yesterday’s steep price drops (the December contract saw a 5% pullback), making the DOE’s forecasts, if not suddenly prescient, slightly more relevant.

When the DOE issued its STEO (Short Term Energy Outlook) at the start of October, the average difference between its forecasts and the NG settle price was $1.27.

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Today, with the market’s downward correction, the average discrepancy has shortened to $0.99, implying prices have moved closer to the DOE forecasts. Can we expect them to move closer still?

The current confidence interval for the December contract is ($4.53, $6.00) putting today’s value of $5.21 or within 79 cents of the upper level and 65 cents of the lower level.

For the January contract, the CI is wider at ($4.60, $6.70) and current settle of $5.55 well within this range.

In comparison, the DOE’s October forecast puts the December contract at $4.23, 30 cents below the lower CI, and the January contract at $4.70.

Further out, the DOE predicts a backwardation in summer 2010, with August prices being 10.44% lower than February’s. In contrast, the August 2010 contract is currently trading at a 4.3% premium to the February contract.

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Thus, while the DOE’s forecasts may be too close to the confidence interval in absolute terms, they may still suggest that the August contract is overvalued in comparison to February and other pricing patterns for the coming year.

Looking at the confidence intervals themselves, we can be 65% sure that natural gas prices in Q2 2010 will average less than $7.45, while Q4 will average less than $9.29, well below the $12+ peaks we saw in Q2 2008. Here at The Schork Reportwe are looking forward to the DOE’s November STEO release next month to see whether they have started to factor in a more bullish outlook for the natty and crude contracts.

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Stephen Schork is the Editor of, "The Schork Report"and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.