Financial Intelligence: How Arbitrage Forensics Provide Insight into Saudi Knowledge

The following is from guest contributor Jeff Vail. Jeff is an intelligence analyst focusing on energy and infrastructure-related issues. He is a graduate of the US Air Force Academy and a former USAF Intelligence Officer. Jeff previously wrote on the The Oil Drum about the increasing violence in Nigeria.

He discusses an interesting phenomenon with respect to energy futures prices, that long dated futures are limited in how much they can go up (but not down) based on arbitrage principles. Because the price of distant oil futures quickly rise alongside spot market prices when spot markets are moved by short-term events, we can infer that major producers such as Saudi Arabia think that the future price of oil will be much higher than the price at which distant futures are currently trading. This provides further support to the theory that they don’t believe their own statements on their future production or on the future price band for crude oil. Jeff's post is under the fold.

NYMEX Futures Strip for Light Sweet Crude 3/29/07 (Click to Enlarge)

Financial Intelligence: How Arbitrage Forensics Provide Insight into Saudi Knowledge

There has been quite a bit written recently about what is “really” happening to Saudi oil production, as opposed to what the Saudis are telling us. Comparison of rig-count to oil production levels, or analysis of published seismic readings of water encroachment on a reservoir provide good insight, as Stuart Staniford has shown in several, recent, articles. This article is to suggest that additional, complementary information about Saudi oil production can be gleaned through forensic analysis of the related financial markets. Just as reservoir analysis is quite complex, this financial analysis will be fairly challenging—please bear with me, I will do my best to explain the financial principles at work in this analysis (and please don’t be offended if you already understand arbitrage!).

EXECUTIVE SUMMARY: Because the price of distant oil futures quickly rise alongside spot market prices when spot markets are moved by short-term events, we can infer that major producers such as Saudi Arabia think that the future price of oil will be much higher than the price at which distant futures are currently trading. This provides further support to the theory that they don’t believe their own statements on their future production or on the future price band for crude oil.

One of the basics principles of finance is the “Law of One Price.” This states that, for any fungible and definable good (such as oil), all future prices flow from the spot price. Say, for example, that the spot price of NYMEX Sweet Light Crude is $60/barrel. The Law of One Price says that the future price of that same barrel of oil in one year is not an independent price, but rather is dependent on the spot price: it is $60/barrel + “risk-free” cost of money over 1 year + cost of carry (storage) for one year. If the future contract is trading at higher than this predetermined cap, then arbitrageurs can make risk-free profit—they sell the future contract, buy the spot oil, and store it until the future contract matures, collecting the excess as profit. This represents an upper limit, an “arbitrage cap”—the price of oil for delivery one year from today cannot exceed a set amount above the spot price, or arbitrageurs will act to correct this price distortion. It should be noted that arbitrage price cap can actually be lower than the spot price—this happens when the cost of money is negative over the time period (either due to general deflation or specific yield-curve environments).

In contrast, there is no limit to how much lower the future price of a good can be from the present price because arbitrage cannot act to correct such a disparity. If oil is trading at $60/barrel today, there is no reason why a future contract for delivery in one year can’t be trading at $30/barrel. A trillion barrel oil field could be discovered in upstate New York—not very likely, but we just don’t know. The point is, it is theoretically possible for traders to find some good reason to price oil much lower one year from now than today’s spot price. Arbitrage has no mechanism to correct this disparity—you can’t buy a future contract to cover a sale of oil today.

Returning to the upper limitation on future pricing: what happens when future prices push up against this arbitrage cap? Arbitrage acts to bring the prices in line with each other. But in doing so, does the future price come down, or does the spot price go up? Let’s look at the mechanics. An arbitrageur looking to exploit a future price that is too high relative to the spot price must buy oil on the spot market and sell oil on the future market—this increases current demand (relative to current supply) and increases future supply (relative to future demand). As a result, both the future price comes down, and the spot price goes up. However, the volume on the future market is invariably much lower than the volume on the spot market, so the arbitrage trades bring the future price down much more than the spot price goes up.

As we’ve discussed, the spot price of oil cannot “push up” the future price via arbitrage. The spot price does set the psychological expectations of traders (as humans tend to extrapolate the present when predicting the future), but there is no arbitrage mechanism that forces short-term, supply-based price increases (such as the shut-in production following Hurricane Katrina) to push up prices in the distant future. Why, then, do actual price changes seem to contradict these accepted principles? Now things get interesting…

When there are short-term, supply-driven increases in the spot price of oil—such as the recent increase that can be partially attributed to the capture of British sailors by Iran (see chart below)—this price increase should not also increase the price of a future nearly four years out. And yet it did…the price of the December 2012 contract increased right alongside the spot price over the past few days. Why???

Because of the limits imposed through arbitrage, the price of oil (based on the future contract price) in 2010 can’t greatly exceed today’s spot price of oil. The future price of oil can, however, be significantly lower than the spot price—and when short term events push up the spot price significantly, this might be normal occurrence. After all, an incident in the Persian Gulf, or a hurricane in the Gulf of Mexico have little bearing on the supply/demand picture for crude oil five years from now. But in the past few years, as soon as short-term spot price movements create space under the arbitrage imposed future price cap, the future price seizes the opportunity to move upwards. The explanation for this is that the future supply/demand equilibrium is at a price significantly higher than the future is actually trading, because that future price is constrained by the arbitrage cap. Whenever space is made available under the arbitrage cap, such as by current events, the future price will quickly rise to fill that space.

Figure 1: Illustration of distant future market closely following short-term spot market price movement to fill available space under the arbitrage cap.(click to enlarge)

If the future price of oil were significantly below the arbitrage price cap, then this would be highly significant to the Peak Oil debate—it would represent the market intentions of major producers who, with full access to their internal data, believed that the future price would not be significantly higher than the present price. Conversely, because there appears to be zero space available under the arbitrage cap—even when events temporarily increase the spot price—we can discern that these major producrs believe that the future price will be significantly higher. In reality, this calculus applies primarily to only one producer—as Saudi Arabia is the worlds largest exporter, and as most future hopes for oil supply increase seem predicated on their claims, then they are the only market player whose future production has a high likelihood of setting future prices.

If Saudi ARAMCO actually believed that it would be producing 12+ million barrels of oil a day in 2012, and that prices would still be trading in a band of roughly $60/barrel, then it would have significant motivation to sell oil futures for delivery in 2012. Why? If it can get $68 today for oil to be delivered in 2012, and it honestly expects oil to be trading in the $60s in 2010, it would be crazy not to sell the future today and invest the money in a bond or other financial instrument. Even at a 3% rate of return above inflation, selling a Dec. 2012 contract today for $68/barrel is the same as selling that same oil in Dec. 2010 for $81/barrel (in 2007 dollars). If Saudi ARAMCO did believe what it publicly states it believes, then it would be happy to sell oil for delivery in 2012 at $68/barrel (today’s future price). Or at $67/barrel. Or at $66/barrel—this motivation to sell even at prices below where the future is currently trading would bring the future price down—it wouldn’t jump to fill space created under that arbitrage cap by short-term influences. Because this is not what is happening—in fact, because the opposite is happening and future prices rise immediately to fill any available room under the arbitrage cap—we gain a very valuable insight into the inner thinking of the Saudis. What insight? Because the future price jumps to fill space created under the arbitrage cap, we can infer with high confidence that the Saudis don’t believe their own rhetoric. They don’t believe that they’ll actually be producing 12+ million barrels of oil per day in 2010, they don’t believe that the price of oil will be less than $80 in 2010. If they believed anything close to this, they would happily sell 2012 futures now for $60/barrel or less—far less than the current price—and this would bring down market prices. This is, in my opinion, highly significant because their access to their own data puts them in the best position to make assessments of the future of global oil markets. If actions speak louder than words, then this is the real Saudi press release: “We’ve peaked… ”

- "If the future contract is trading at higher than this predetermined cap, then arbitrageurs can make risk-free profit—they sell the future contract, buy the spot oil, and store it until the future contract matures, collecting the excess as profit."

Try booking 12 month storage at Cushing from the storage owners, they will extract the full rent the market pays in the forward contango and you will end up losing money. There is no such thing as a risk free profit except in text books.

- "If it can get $68 today for oil to be delivered in 2012, and it honestly expects oil to be trading in the $60s in 2010, it would be crazy not to sell the future today and invest the money in a bond or other financial instrument. Even at a 3% rate of return above inflation, selling a Dec. 2012 contract today for $68/barrel is the same as selling that same oil in Dec. 2010 for $81/barrel (in 2007 dollars). "

The seller of 2012 $68 futures contract will only get paid the money on delivery of the product in 2012. Thus the NPV (at 3% bond rates) is $55, not $81 (haven't checked the math, but going by the example given)

In simple terms, imagine agreeing to sell your house to someone else for $X, the sale to go through in 2012 and money to change hands then. To monetise this, you have to take the contract to the bank who will then discount the value by the interest rate applicable and the risk of the eventual buyer defaulting at some point between now and 2012.

The bank is going to discount by a rate higher than the average 5 year interest rate and then give you a credit haircut on top of that, and a risk haircut if your house is in Iran, Angola, Saudi, etc, for example....

In other words, though futures prices are nominally higher, they are lower than spot prices in terms of net present value.


Two good points that both represent barriers to entry to the world of arbitrage for small-timers. But they don't apply to producers and institutional players--the ones whos behavior are dictated by these dynamics.

If I want to go book storage for a thousand barrels of oil, I won't get a great price. Major players, on the other hand, can demand efficient pricing for oil--because they have the leverage to own their own storage facility if industry providers aren't providing it at a competitive price.

Likewise, if you sell one 2012 future, not only do you not get the money now, but you have to actually put up money to cover your liability. Major producers, however, are treated differently. They get a significant chunk of the money today if they operate on the NYMEX, and they can do even better if they enter into forward contracts that track NYMEX prices.


Agree in theory. However.....

Building new tanks may be more difficult in practice than in theory, planning permission etc. You still have to pay to access pipelines, etc. Anyone building new tanks is doing it on the Gulf Coast where the real market for crude is, not in Cushing.

Major producers sell forward swaps to banks (Goldman, Morgan Stanley, etc). The banks discount them for interest rates, credit risk, location risk (resource nationalism etc), war risk, etc, etc, etc. Ultimately they get less than spot price on this...

I am not aware of any major producer selling futures strips on NYMEX, margins are too high and liquidity is too low. The banks do all this business and there is constant flow of forward producer selling in the swaps market.

Addendum: a LOT of forward producer business has been done in "costless collars" where producers buy a put option below the market and sell a call option above the market (eg $50 and $80). They are therefore guaranteed a minimum of $50 and a maximum of $80 and take floating price vs NYMEX for anything in between. There has been so much of this business in the last few years that put options are priced relatively higher than call options, known as an inverse risk reversal skew. Crazy, but true, and a reflection of real pricing flows in the market...

For those who may not be familiar with the term "risk reversal", it commonly refers to the difference in option implied volatility between the .25 delta calls & puts.

I first encountered these in the FX markets back before the Euro came into existence. "Back in the day", large volumes of risk reversals traded on Dollar-Mark, Dollar-Paris, etc.

Correctly modeling the skew is crucial to more than just the pricing of risk reversals, but to screwball derivatives of all types (e.g., single- & double-barrier knockouts & knockins, in-the-money payoffs raised to a power and then capped, etc.).

Trying to translate using my other post. I thin they are trading out to their strong probability positions.

Assuming I'm right and hedges are use to setup big win probability distribution and limit losses. At the end of the day I cant see how positions don't translate into probability maps of gains and losses with various crystal balls. This means even slight contango in the market snapshot is a big deal.

"They get a significant chunk of the money today"

Are you sure about this? My understanding is that commercials get a lower margin than specs but that it's still a margin. Your comment seems to refer to forwards (off exchange) rather than futures.

forwards are not settled until the positions are closed either. Low credit players might have to put up an L/C to cover the risk, but no money changes hand. Better risk players will have margining agreements with each other...


Major producers, however, are treated differently. They get a significant chunk of the money today if they operate on the NYMEX, and they can do even better if they enter into forward contracts that track NYMEX prices.

all players on the NYMEX have to post margin. It's less for the big boys with good credit, but there are no freebies. And no one collects on open positions until they are closed.

No one pays on forwards until they are closed either. margining takes place unless the entity is given open credit. No doubt Saudi would get open credit from Morgan, but no money flows would take place until settlement.

"buyer defaulting"

The exchange prevents this from happening in futures contracts by acting as the intermediary party -- and keeping margins current by daily settlement.

I also don't think it is correct to use the risk free rate to discount Saudi's cash flows.

The discount rate should be Saudi's cost of capital, or the return they would get on the next best investment with a similar risk profile. Storing a volatile commodity is hardly risk free, even though Saudi may have special knowledge and ability to influence the price. I would be an interesting exercise to try to calculate an appropriate cost of capital for this investment. There are an awful lot of factors involved. I would guess a reasonable estimate would be more like 7-8%.

the debate is meaningless. The saudis don't hedge. Neither does Exxon or any of the other majors on their forward crude production. The sellers down the curve are smaller players that have high cost production and banks eager to make sure their loans get paid.

Excellent article...I have been wondering when there would be a guest post on the signals from the forward oil curve. The only thing that has stopped me from sinking $50,000 into long dated contracts (or better yet, options on those said contracts) has been the fear of the margin call on a short term spike down.

The curve is not in perfect contango, so there is still some arb. cap beyond 2009....

The floor was back at the beginning of the year and even now it can pop down to $60, but with spring/summer coming and the market moving down gradually, shit hitting the fan won't commence until next year. This year will simply be a painful pin prick.

There's another thing to add to your comment. As SA refines more of it's own oil, less is sellable on the exchanges. This could have a weird effect. lately WTI has trailed Brent by a pretty wide margin, as much as almost $4 for a brief time. This is VERY significant.

As more refineries open in Asia and Close in America, the US petroleum reserve and WTI oil have less of an effect on price. Why would someone buy $68 light sweet in Beaumont for delivery in 2009 sitting next to a trillion barrels that can be fed to a dwindling number of refineries when they can pay $47 for the Saudi basket deliverable to indonesian refineries.

People seem to forget, benchmarks are only good if they reflect real supply demand. That's why the Omani benchmark isn't used any more. This is why the crack spread is so wide. Spot price is a supply chain phenominon, as Platts loves to remind us.

Excellent point. I have made a number of posts recently explaing why WTI is a poor benchmark for crude pricing. Cushing is landlocked and the pipelines servicing it are mostly owned by the refineries who also happen to own the storage tanks.....

Interestingly though, TEPPCO is allegedly discussing reversing the flow on the Seaway pipeline (currently flowing 280-350 kbpd from Freeport TX to Cushing) and will announce today the completion of the Takeaway pipeline from Midland TX to New Mexico (which will also reduce flows to Cushing).

lately WTI has trailed Brent by a pretty wide margin, as much as almost $4 for a brief time. This is VERY significant.

Yes, it is significant, but what does it really mean? My take is that it reflects the premium for tanker delivery as opposed to Cushing delivery. That Asian refiner is not exactly at the end of the NA pipeline system.

it reflects a heavily contangoed market. Nobody really needs prompt wti and storage is full. The fear factor is boosting later delivery and more so in Europe as Iranian crude is actually refined there in a significant amount.


Refineries may have closed in the USA, but we are refining a record amount of crude. The number of crude units is not meaningful. Their capacity is.

Brent/WTI is not really that inverse to normal. You are looking at prompt futures to prompt futures and there are no jet deliveries of crude oil to make that happen. When April WTI dropped to $56, May was $59. Brent was a only a little over May.

My guess is Brent is over WTI right now because European refiners actually use Iranian crude and are nervous about it. Also May/June is maintenance season in the North Sea. Its the period when the BSDs would try squeezes as production was at its min while demand was good.

Do we have any evidence that the Saudis have been active palyers in the futures market in the past? As the major swing producer, they would be foolish to do so-- nobody would trust them, or the markets, anymore. Sort of like the ultimate insider trading: they quietly go long, then announce a quota cut, or they go short, and then announce a production expansion.

I just don't think that we can use a market in which the Saudis do not participate to gauge their future actions.

Clear data on how Saudi insiders participate in the markets would require the very transparency that we don't have. Additionally, the ability to participate in the market is just as relevant as actual participation--it represents opportunity cost to all other actions.

The volumes on the NYMEX for the crude oil future contract don't appear to be sufficent for the major oil producing countries to effectively hedge. Although daily volumes have been exploding -- record contracts increased from 162,000 in 10/06 (each contract representing 1000 barrels of oil) to over 800,000 in 1/07. It seems to me that if Saudi Arabia wanted to lock in its future production of 7-10 million barrels per day it would need more than 160-800 million barrels per oil traded per day otherwise the price would be moved too much to the upside (although I'm not exactly sure how much more volume would be needed).

Although with low enough volumes on the futures exchanges KSA could (1) sign large volume long term contracts tied to the spot prices and (2) then manipulate the spot prices with very little effort to leverage those contracts. Still, given the volumes of liquids being moved every day and the other considerations KSA must have (eg, preservation of monarchy and the present tight connection between royal heads and royal bodies), I do not see them messing with the futures market that much.

With hundreds (?) of billions of barrels in the ground, and their entire economy dependent on oil exports, the net Saudi position is always long, never short.

For comparison, applying the same logic how do the future prices during the seventies fuel crisis look?

There were no futures then...NYMEX started trading crude in 1983 IIRC....

Heh, displaying my ignorance every day...

Hi there folks. I hope people will digg, reddit, and SU, etc., etc., this story for Jeff. It's a good one. Thanks!

Not to disagreewith what is said here, but the other looming variable is the actual value of the currency this future is denominated in. As was demonstrated quite siccinctly in the 70s, inflation - or rather more accurately the printing of money - can make a complete mockery of future prices. Given the US current foreign obligations, which a further rise in oil prices would only aggravate, I see no reason to expect that the correlation between today's relative value and that of 2012 would be any closer than it was then.

In Euro terms, the price of oil has not moved up nearly as much as in dollar terms. Or, put another way, the US dollar IN OIL TERMS has fallen much further. I'm more certain of the value of oil than I am of any currency including gold. How we manage to continue an historically growth based economy given the deflationary effect of a dwindling oil supply will be the condrum of the new century.

I'm more certain of the oil supply five years oout than the money supply.

That needed to be mentioned. it's hard to think in so many dimensions... crude grades, shipping, supply chokes, refinery locations and currencies. This is why markets work so well. We all learn how "smart" we really are.

I should have sUccinctly said conUNdrum - and that's a Freudian Canadian oout!

Fascinating article, thanks for sharing! I know almost nothing on this subject.

Many have pushed the argument (Michael Lynch, etc.) that the price increase since 2004 is mainly due to speculation (hedge funds, etc.). I would like to know your opinion on this? I would suspect that speculation would leave some kind of signature (e.g. number of non commercial contracts versus commercial contracts, etc.).

I think that speculation has had some effect, but that it is primarily an easy excuse that people can point to when they want to explain price increases without addressing supply issues.

Speculation is certainly an issue with financial instruments that aren't pinned to reality through delivery of tangible goods. But oil, as with some other commodities, is constrained by fixed supply and is traded in contracts that are subject to actual delivery. So while speculation can drive up the price of shares of Google, there is no "delivery" of some tangible "google" good at a fixed date--price is entirely theoretical. Oil prices are at least partially pinned to the reality of the supply and demand picture because it is traded in instruments that must be delivered at a definite date.

Bottom line: oil prices are the result of an equillibrium between supply and demand. I'm sure there is some degree of speculation (though it's difficult to tell who's speculating and who's hedging in some manner), but if speculation has driven prices up, this increases the incentive for producers who are capable to produce more today. The fact that production hasn't risen to burst this "speculative bubble" is, if anything, evidence that the bubble is not speculative at all, but rather the result of supply limitations. So I think that listening to talk of "geo-political premium" or "speculative premium" come from Lynch or CERA is evidence that they'll do anything to avoid talking about supply limitations. After all, academic economists will tell us that commodity prices should always go down!

the only place you can speculate is on the futures market. Kurt Wolff gets around this by using 6 year futures.

Right. Speculators can only influence price in the short-term and can only make money if they are right. If there was ample supply coming that would drop prices in the future, it is still possible that a crowd of stupid speculators would rive the price up, but when supply came on line, they would lose their shirts.

All speculators can do is to anticipate a price increase and buy in advance of it. This is true for oil, currencies, stock prices, real estate, etc.

The fact that production hasn't risen to burst this "speculative bubble" is, if anything, evidence that the bubble is not speculative at all, but rather the result of supply limitations.

Or that it wasn't a bubble. The speculative activity correctly anticipated the price increase and the market was right again.

it is also crucial to note, as you did, that it is not possible to divide the world into speculators and non-speculators. If a refinery hedges we say they are not speculating, but merely covering risk. but then if they decide not to hedge, are they then speculating? What about an investor with a portfoio that has oil exposure (say Korean equities), that enters into a hedge? There is a huge amount of overlap and one can "speculate" by doing nothing.

All of this is extremely interesting, and it sounds very scientific. Yet, looked at more closely, it sounds like maybe the discussions between acolytes of Tiresias (the Greek seer who ultimately led to the discovery and downfall of Oedipus). Are we looking at "real" facts, or bird entrails, or copulating snakes? And how is anyone really to tell the difference?

Seems to me that arbitrage is a giant casino, with the odds in favor of the house, and the players competing under significant and unequal financial handicaps -- but individually they win just often enough to keep them coming back for more. (The principal of random reinforcement.) My friends and acquaintances who gamble all say the same thing when they come back from Reno or Las Vegas-- "I had a great time, the food was cheap, and I broke even." Well, of course, those places wouldn't be there if everyone either broke even every time, or even more important, couldn't be made to believe he broke even.

What's the point? Well, there are a lot of variables that the oil arbitrageurs don't and can't know or control, and the whole thing can spin out of control (c.f. Long Term Capital Management, or the U.S. Savings and Loan collapse of the 1980's)-- in which case, the entire society is drawn in through taxation, giant financial manipulation or war to save the House.

An old financial partner of mine used to play poker at the Elks club every Thursday night, and he always made money. He played his cards straight, and he never drank. Some would say he never had any fun, and he wasn't playing by the social rules -- his world of total moderation is certainly antithetical to a world that demands novelty and risk.

Digg'd your article, Nate.

Question for all: how does a peakist get in on the futures market? can it be done with $50-100k? Anyone making some dollars on the backs of the blissful MSM?
I want to buy 16 PV panels to shine at my neighbors mcmansion this year...


Its Jeff Vails article - i just formatted it.

You can buy one futures contract which controls 1,000 barrels of oil ($64,000 worth) for margin of about $4000. I wrote about how this works here.

Basically you can put up as little as $4000 or as much as full price, depending on how much leverage you want. The more leverage, the more risk that a downtrade (due to recession or some such) will eat away your margin. Its risky but you dont make high rewards without commensurate risk.

You can open a futures account with any number of brokerage firms - I use Man Financial but there are others.

And as an interesting but scary bit of oil futures trivia:

If we have reached peak oil we've used 1 trillion barrels and there are 1 trillion left. However that trillion will require more energy to extract, so lets call it 660 billion after then energy costs are subtracted (for ease of argument sake). With world population of 6.6 billion, that is 100 barrels left forever for each person on the planet. Yet for $4000 you can control 10 times that amount - 10 times yours and all your descendants allotment.

Kind of bizarre when looked at in that way.

Personally, I prefer options on futures to owning actual futures contracts. They are probably not the right choice if you're a large player who will be trading frequently, but I think they're preferable for the small, individual participant. Options have three primary advantages IMO: 1) you can't lose more than you pay for the option, 2) the price of entry can be lower, and 3) you have more flexibility because you can buy options near the money or far out, and the lower price of options well off the money make it possible to buy several options--this allows you to more effectively use options to hedge against personal exposure to energy prices.

At the moment, a call option (i.e. going long on oil) for the December 2010 futures contract at a strike price of $100/barrel is selling for $2200. This means that, for $2200, you make $1000 for every dollar over $102.20 per barrel of oil on November 15, 2010. IMO, this is an excellent hedge--it is probably best to not consider it an "investment." It can potentially hedge against loss in suburban home value, loss in 401k value, higher home heating and gasoline bills, etc. But as with any investment, don't take my word for it :)

I think everyone on this board expects oil to be WAAAY above 102 in 2010. So would it be smart to put 50k in to a future option contract now or wait a bit.?

If I'm hearing you right I could make a couple of million dollars iff oil is 200 in 2010, which I think likely.

Am I right????

Is it that easy?

"Is it that easy?"


The risks are manifold. Recession/Depression. Bird flu. War in the Middle East causes a gigantic increase in prices that causes massive forced conservation and an across the board push for more efficiency and a permanent change in consumption patterns. The list goes on and on.

no its not that easy.
because the first wave of demand destruction will be higher than depletion near the peak.

remember peak oil is a bad thing, but it also represents the MOST oil the world has ever had. so a recession/depression led demand elasticity might sink futures from 100 down to 50 before they go to 200. if you are well heeled and can stomach that interrim pain then yes its that easy.

of course, there is the other risk that the 'man' will NEVER allow oil to be at $200 and geopolitical conflict interrupts the natural market trend of oil getting that high.

logically you are correct, but there are numerous tiny wrenches that could be thrown into your investment scenario

i agree with simmons. most likely next decade we have wild volatility with higher highs and higher lows - i expect we break last years high of $80 by this summer go to 90-100 then steep recession brings us back to 50-60. but my confidence in that scenario is about 20% (but higher than the 10 other scenarios i can concoct)

How about investing in a professional Oil futures fund?

So if I invest now and oil goes to 50 next year do I lose my investment?

If you want an easier, lower-octane play, then consider the exchange-traded funds XLE and/or OIH. These invest in oil and oil service companies and not the underlying commodity.

Oh, and if someone says USO, just say no... (its a ETF that rolls near term futures)....

I have some $ in USO. What's the down side?

It's losing ground against what it's supposed to tracking:,$WTIC

For discussion see:

EEK! Danged if it isn't. Don't reckon I'll pull it all out right before Iran gets bombed, but still....

Is there a thread in the past where the VERY bright regulars here discuss what they are doing to invest in oil, etc? For those of us with only modest $$?


Hi green,

Someone had just mentioned this to me, in fact. An inheritance, for example. What to do w. it? So, I'm curious about what people would say, though I'm sure that a lot depends on the circumstances and also that nobody really (really) wants to give advice.

Anyway, my suggestion is to ask this again tomorrow. It's kind of late in the day on this thread, perhaps.

If you post this question again tomorrow, I will try to respond in more detail. For now here are some general points:

1) Every single investment is essentially worth what you pay for it. You think it is worth more and someone on the other end thinks it is worth less. You may both be very smart.

2) There is really no such thing as a good investment outside of the context of who is investing and what else they hold. There is an expression that says that 90% of returns are explained by asset allocation, not choice of individual investments. That means how much do you put in bonds, real estate, cash , and equities is much more important than what equity (or derivative - which is what futures are) instrument you select.

3) Following this, generally speaking younger people can take more risks and should have more money in stocks than an older person. It is extremely risky to put money you may need within ten years into stocks.

4) It is incredibly difficult to beat the market. There is much debate about whether professionals can, and they have access to huge amounts of research and advice and are able to follow their investments daily. You can get the market average return by investing in an index fund (stocks, bonds, etc.). A decision to invest in individual stocks or a set of stocks implies that you think you are smarter than the average investor.

5) Other commenters (Valuethinker I believe) have listed some very useful investment books. I like a Random Walk Down Wall Street, which is half basic finance and half investment manual. it is also pretty short and easy to read. If you are really going to make investment decisions that impact you life, put a bit of work into it.

6) Advice on individual investments is very dangerous and has a low likelihood of success. For a holder of the Chartered Financial Analyst (CFA) designation, it is unethical to provide investment advice without knowing the financial position, risk tolerance, current investment profile and investment objectives of the investor.

I took finance courses with a professor who previously taught at Wharton. He said when they sat around the coffee room and talked about investments, it turned out that they all had virtually all of their money in index funds (aside from real estate) and only played around with about 10% in individual stocks, just to have fun.

If Wharton professors don't think they can beat the market, you need to ask yourself why you think you can.

The traditional approach would say that you should allocate investments between cash, real estate, bonds and equities. When you are young, a portfolio can be equity heavy. As you get older it should move towards less risky instruments (bonds and cash). Investors should make an effort to be diversified (index funds are automatic diversification) so that a loss in one investment won't sink you.

Oil futures are a "good investment" for some people as a small portion of their portfolio. You might put all of your money in oil futures tomorrow and if they gain, get rich. It would still be foolish, just like betting all of you money on a coin toss would be follish, regardless of whether head or tails came up.

How about Canadian oil & natural gas royalty trusts? I am invested in ERF; it pays 10% dividend with very little risk if we are anywhere close to peak oil or peak natural gas.

Definitely not easy. I have prospered trading futures, using the same broker as Nate. But, it requires a certain emotional equanimity. In the past year, I have weathered:

1) The May 11 - June 13 all markets takedown. This was a coordinated central bank action set off by threats to reduce market liquidity and the yen carry trade. The threats were hollow, but a lot of commodity speculators were cleaned out. I sold near the top and got back in near the bottom, very sweet.

2) The end of summer (pre-election) energy market takedown. This was done by JPMorgan depressing natural gas futures to clean out the Amaranth hedge fund. Also GoldmanSachs reduced the gasoline fraction of their commodity index taking down gasoline and crude oil. This one blindsided me and I got bruised. It was the biggest drop in oil proce since 1991.

3) The New Year oil takedown, enabled by a blizzard of media propaganda about a new oil glut. My worst two trading days ever. However the $49.90 bottom was an excellent re-entry point. In the end I came out ahead.

4) The end of February all markets retreat triggered by a 9% single day decline in the stock market in China! Gold was suppposed to be a safe haven in such times. It wasn't.

In all, oil has been a rotten commodity investment forthe past year and a half, we are still below the August 2005 price of $70! Only by taking advantage of price swings has it been possible to make money. Contrast this to a REAL bull market, uranium or any of several base metals, or corn, or soybeans.

For most folks, I would suggest if they wish to play with oil futures to invest in the long dated futures without using leverage. That way there is no need to follow the markets every day and one can sleep soundly.

Wise advice....

"Is it that easy?"

I'll disagree, superficially, with the others: Sure it is. As long as the price of oil is $200 in Nov. 2010, you'll make a killing. Now I'll agree with Nate and Westtexas: There are a lot of arguments why this may not happen. Remember, if oil isn't over $100 at expiration, then the option is worth ZERO.

What it sounds like you're considering is speculation (don't confuse this with an investment). Specualation is fine, just make sure that you know that you're gambling. On the other hand, I *do* think that there are some very wise hedge plays available. You could use a cross-commodity collar to simultaneously hedge against rising oil (by purchasing a call option well out of the money) and a falling S&P500 (by purchasing a put option well out of the money). This way, if oil is $200, then you make a fortune on the oil option and lose the full value of the S&P put (which is insignificant in comparison). Conversely, if oil is only at $60 because of massive demand destruction or deflation, you'll lose the full value of the oil call, but make a fortune on the S&P500 put. That's a classic volatility hedge for this scenario: but again, it's a hedge, not an investment.

That's just one of countless ways to play with options...


The Nimitz battle group is headed for the Persian Gulf, which at least for a while, will apparently give the US three carriers in theatre.

Do you think Bush will attack Iran?

As I just told Nate via email, I'm the wrong guy to ask this question. I was so sure that we wouldn't be stupid enough to attack Iraq that I booked a vacation to Kauai for December, 2002. I deployed to Qatar in November, 2002.

That said, I think that even Bush & Co. realize that they'll need to get the American people at least partially behind such an action before it can go ahead. I think that they're trying to ratchet up the tensions to increase the probability of a "Gulf of Tonkin" style incident gives them that support.

On a related topic, an article that I wrote a while ago:

Keep an Eye on Khuzestan

Never forget that price depends on the demand curve, too. The pessimists at The Oil Drum believe demand could really get clobbered.

Historically, recessions moderate consumption even in the US.

Since hes not posted yet, I will reiterate that Jkissing has reminded us, on numerous occasions, that despite several recessions in the 1970s, oil went up 900% and never had a year over year decline in price....

of course this time may be different - what with all the credit expansion and debt out there...


This is simply not correct according to BP.

Check the BP Annual Statistical Review for 2006

Note that the price of oil was flat '74 to '75 but falling in real terms. Crude fell in real terms from '77 to '78.

Also note that crude fell in nominal terms and even more in real terms in 1980 to 1981.

During the '70's as a whole, of course, GDP was rising. The economy expanded in real terms, so one could expect crude to trend up during the whole period (even apart from embargoes etc).

In addition, take a look at the price action immediately before the early '90s recession (it was rising) and during (it was falling).

jkissing and I had an exchange on this in the comments associated with this piece:

He has so far offered no response to my citing these data.

SUMMARY: There is no historical case for crude prices rising while GDP is falling.

Prices did rise in 73/74 during a recession, of course, under pressure from extreme artificially applied supply constraints.

you admit:
Prices did rise in 73/74 during a recession, of course, under pressure from extreme artificially applied supply constraints.

And according to West Texas, exports will drop 50% in 5 yrs, 4 now.

So this will put extreme pressure on price no matter what gdp does because unlike the 70's the supply will not be there at the other side.

Which is why Simmons projects 300 dollar oil.

And I don't think the CERA listening market sees this.

I don't accept WT's projection of a 50% drop. Too big of a fall, in my view. But that's a bit off topic.

IF you buy Westexas' story, I agree there could at least be a spike into 3 digits.

But don't count on its staying power in that scenario.

Why not ?

I mean Europe and Asia have more cash than the US once the bidding war really gets going they can handle 10 gal gas better than we can. I see no reason for it to drop.
Now I can't see gasoline going much over 10 gal since at that point you can make if from food grade vegetable oil cheaper.
I'm guessing the real cost for reasonably renewable organic fuels is in the range of 10-15 USD a gallon.

The first wealthy country thats going to be priced out is the US. Demand drop off here at prices in that range will ensure supply meets demand.

And according to WesTexas, exports will drop 50% in 5 yrs, 4 now.

Should be: May drop by 50% in five years, IF Russian oil production starts falling this year or next year, and I am talking about the current top 10 net oil exporters. Some smaller exporters are showing increasing exports.

In any case, based on some assumptions about consumption, I estimate that net exports by the top 10 fell by 8% from 12/05 to 12/06. This would be a 50% drop in 9 years.

However, remember the UK went from probably max exports to zero in about five years.

I knew I had been writing a lot about net exports when I did a Google Search for Net Oil Exports 2006, and two of the top listings were related to stuff I wrote.

Another way to look at it.

60 seems to be a price that knocks out the poorest countries and introduced some belt tightening.

The next level bidding war will between basically equally wealthy countries with the US as the weakest.

This means price has to rise until significant demand is destroyed in western economies. This is much higher that 60 probably closer too 300-500 or more.

So its not a gradual sweep up but huge leaps as wealthier and wealthier bidders bid for the remaining oil.

Only fairly major economic contraction will bring it back down and even this price will stay high enough to ensure demand continues to decrease. This means continued pressure on first world economies. Basically its economic warfare at that point if not shooting wars.

300-500 sounds good. All I need is a spike in future prices and I've made my money.

So if I buy now at Dec2010 at 100 and this year we have war, hurricanes, depletion and whatnot and the price gets close to 200 I sell. If it only gets to 120 then I give it another year.

What do you think?

Thinnk of it this way, once CERA admits we are at peak and it only going to get a lot worse the futures market will go wild. At least 500 for Dec2012.

The upper bound is only determined by the cost of using natural organic material as feedstocks for making gasoline.
Generally you can convert just about anything to syngas and from there to gasoline/diesel. Also of course coal/NG can be used. The only downside is you have to get enough of these plants going and into production so you actually have a supply. My guess just looking at the cost of vegetable oil in the grocery store is at around 10-15 USD in todays dollars we are easily in the range that any organic feedstock is competitive with oil.

With that said as I pointed out above it takes time to bring this stuff online and I'd assume at those prices you will finally have real demand destruction taking places in the western economies. But between the time that any alternative is viable and you actually have enough supply I think you could expect oil to continue above this natural ceiling at least for 2-3 years so I have no idea how high it could go.

I'd think that the whole system would pretty much self destruct at that point I can't fathom prices much above 300 without systematic problems all over.

The main point is that taking WestTexas's bidding war to its logical conclusion once the battle is between the deep pocketed western nations I see no real upper limit on the price in a short time period except I'd expect a market breakdown before its reached. Long term it would settle at the level that makes alternative and in general any alternative a reasonable investment. So in a pure market one would expect the market to overshoot the price at which alternatives are economical until a combination of alternatives to oil and demand destruction from real damage to western economies bring supply and demand back together.

I actually think that trying to play the oil markets into 2010 is a fools game if we peaked now since I can't see a open market existing at that point. It all depends on when we peak but I'd not invest in anything you can't sell within 2 years of a confirmed peak. Once the dust settles and viable alternatives are in place and demand stabilizes I'd guess we would see a pretty steady price for oil at between 300-500 a barrel depending on demand and alternatives.

I'd assume at that price point we would squeeze more gas per barrel but
Assuming 20 gal a barrel gives
15-25 dollars per gallon
200 a barrel gives 10 dollars a gallon
I think ten dollars a gallon is a low price.
500 seems to be a max at which point even micro syngas plants would be competitive.

We know Europe seems to be making it at about 7 a gallon so guessing at least double to see a major impact makes sense from that side and that gives 14 a gallon.

Personally I'd probably pay up to 10 before I'd look at alternatives. Above that a electric car and lifestyle changes make sense. A simple one would I'm sure people would simple push hard from mixed use areas allowing small stores back into neighborhoods. The return of a corner store would help a lot. I'd assume you would have a lot of empty houses in neighborhoods at that point so they could be converted or torn down and replaced. Of course before this I would have moved if needed to be as close to work or public transport to work as possible. So on this side of though life style changes that practically eliminate personal fuel usage and general economic hardship would limit oil use. So from the lifestyle analysis it looks like 10+ is the upper bound.

Given that three different estimates.
1.) Viable replacement prices.
2.) Simple doubling of a known high price which is not causing problems.
3.) The point I'd personally change and pressure my neighborhood to change

All point to the 10+ USD range as a upper bound on the price of oil with the range 15-25 as a reasonable too overshoot range.

Finally another way to look at it is to assume your car at this point got 40mpg and you live withing 10 miles of work.
This means you drive 200 miles a week at ten a gallon you would spend 50 a week on gas. about 1/5 of your wages if your a poor employee. This is not unreasonable even 15 is doable. And obviously public transport would alleviate some of this. Of course it goes up steeply if you drive further than this so thats and issue.

Thats why I'm giving a 500 barrel or so overshoot price.
That makes it 125 a week and now your certain to have impacted demand. Of course oil is like money so high oil prices have a overall inflationary effect so 125 may have a real effect of 200-300 a week depending. So your for sure well into demand destruction at this price. And of course my above is a sensible driver similar to a EU driver the American is probably toast at the lower 10 gal rate that can be absorbed in the EU or Japan by most people.

So in general you can expect that if its a wealthy nation competition for oil the price will probably go to the 300-500 band and at that point its touch and go if it does not destroy the economies for some time.

India and China would be smoldering ruins well before this.
I suspect this is why Simmons uses the lower 200 USD/bl as a break point.

Hi m,

The same thought crossed my mind -

re: "I actually think that trying to play the oil markets into 2010 is a fools game if we peaked now since I can't see a open market existing at that point."

...though not based on anything in the way of knowledge of markets.

So, I'm wondering...why do you think this? Could you explain a little more? And, if this would happen two years out, might it not happen sooner (for the same or similar reasons)? And...

re: "...I'd not invest in anything you can't sell within 2 years of a confirmed peak."

This seems to be slightly different than your previous sentence. Peak now - only we don't have it confirmed - and we get the situation of "no market existing"? it the confirmation of "peak"? In which case, same q applies as above - might this not regress? (Once "confirmed"?)

If so, this might lead one to think...(I have several conclusions)...well, what do you think?

re: "...I'd not invest in anything you can't sell within 2 years of a confirmed peak."

I don't see a open market for oil once peak is obvious simply because we are losing the open market right now.

1.) Venezuela is selling to China for political reasons.

2.) KSA uses US inventory numbers as justification for production cuts yet does not cut shipments to the US but cuts them to Asia giving the US preferential treatment.

3.) Russia use of Gas and Oil as a political weapon is simply blatant.

In general too much of the worlds oil is now controlled by governments with political agendas as supply becomes more constrained political alliances will determine who gets the oil.

Even on the exchanges oil is less fungible the spreads between the exchanges are widening because of bids for real oil delivery not paper barrels. The free market would have resulted in a closing of the crack spread instead its increased because of the peaking of light sweet. This overall drives oil to be traded via private contract not on the open market with at some point a lot of political bartering as part of the contracts not just money.

All of this leads to a reverse market crash in the sense that the open market will panic once they panic they will be shutdown eventually permanently and governments will take over procuring the oil supply. Effectively a rationing scheme will be used.

re: "...I'd not invest in anything you can't sell within 2 years of a confirmed peak."

A near term peak is open to debate in fact the date of peak will be debated probably long after it has happened since above ground factors will cloud the issues. For example people claim Iraq is capable of 6mbpd now. This is CERA capacity argument. My experience with American politicians and experts favored by special interest is that the grimmer the reality the more they try and spin the truth. The recent housing bubble in the US for example. I expect the same sort of spin if not worse for peak oil.
Generally the reasons behind the spin are to ensure that key institutions/companies involved in the area of interest get a chance to reorganize before the facts become obvious.
In a lot of ways their is nothing wrong with this because its important to lessen the impact of changes to ensure that economic conditions don't change rapidly since rapid changes lead quickly to fear. So its not a bad thing.

On the same hand when your in damage control situations like this investing is very very dangerous your a lot better off converting to safe harbors and take small losses. The small investor does not easily accept that taking a small loss in exchange for safety might be the wisest move.

So on a big scale the markets under priced risk as long as they can to feed growth. Once its obvious that risk was under priced damage control sets in and the big players move to minimize risk while political give the all is well message. Eventually the markets cannot be maintained and risk gets suddenly priced in. Everyone still worried about making a profit gets wiped out.

Again nothing wrong with this since its critical to avoid systematic failure its just that once the market moves to this mode its senseless to try and play the game unless your certain you can afford to lose. As far as the oil markets out to 2010 I'd have to guess that the big players are making their moves with the biggest move to simply not play the market with more than they are willing to lose. So if they think a market is going to be volatile they are not going to try and move the market. I think it was Goldman that re-weighted their index's recently to remove gasoline and I'm sure that all the hedge funds are lowering the amounts they use for speculation in the energy markets because of the volatility.
In general the moves are first to preserve capitol and minimize loss forget about profit in the second phase its to use this capitol to buy distressed companies for pennies on the dollar making far greater real profit than you would have made trying to play a volatile market. And the cycle starts anew. They actually make more money on the downside which is interesting and explains to some degree why our economy bubbles its not for the upside but to allow retained capitol to make enormous gains on the downside.

Back to the oil markets with a intrinsic resource such as oil going into depletion it derails this macro economic model so I don't see the free market for oil continuing to function much past peak. Instead it will move to a barter system with intangibles such as political moves weighted as heavily as actual prices. I just don't see how a free market can happen when you have a depleting intrinsic resource.
As a example their has never been a free market for water in the western US. I expect the oil markets to become like the western water rights situation. You should note that outright war accompanied the distribution of water rights in the west I expect no difference in the case of oil.

Hi, I live in the UK. I think people in the US will be quite surprised just how high a per-gallon cost you are going to be able to tolerate.

I remember when we fist converted to Litres from Gallons and it was something like 30pence/Litre. We are now around 90p. There was a spike a few years back and some of the machines wouldn't charge past 99p... There is now a three digit counter on most of 'em and it will probably get used soon...

Big difference is we have had 15+ years of high prices to 'get used to it' -smaller cars, more public transport, less suburban sprawl overall.


I tried options on futures, and for the reason you mentioned, you can only lose what you put on the table, no more. However, the problem I encountered is liquidity. Market orders get terrible fills and limited orders didn't seem to get filled. Still back to the same old problem, the individual retail investor ends up the loser.

That's been my experience on stock options too. Unless you trade only the most liquid options, it's mostly a losing proposition for the little guy because the spread is so steep that your option has to have a huge positive move (positive being whichever direction is a gain for your option) just to break even.

Programmed trading makes it even harder. If you have multiple PC's, you can often watch the programmed trading via streaming quotes when you enter an order. If you enter a bid/ask that will put you at the top of the queue for most non-liquid options, you can watch the queue instantly move to ensure your order never gets filled. You can watch the whole queue move in unison--it's pretty strange. The moral of the story is to stick to liquid securities if you want to trade options as a "little guy."

Zero Sum game...understand that first. Next, understand the big guys involved make all the money at the expense of all the lemmings who think they can do it better. Institutions set the margins.....

Yep. And it's easy to trap the neophytes. Get a few small wins under you belt, get more confident, start placing bigger bets... Eventually, the little fish gets eaten alive. Many of the little guys never get to the point of realizing it is a zero-sum game and they are going to lose and the big guys will win. Once I learned that, I quit except for a few covered calls when the market is severely overbought.

Most of the companies that hawk options trading courses, like BusinessWeek, lead potential investors/students to believe that once you learn their tricks and techniques you will be lining your pockets with gold. You can literally see the $$$$ in students' eyes. Once they are actively trading, they often lose their "pot" in short order and quit trading. But meanwhile, the hucksters got several thousand dollars for the classes, the brokerage made a bundle in commissions, and the big guys got your principal. Unless you are wealthy enough to absorb the potential losses, it's a tough place for the small guy/novice.


However, the problem I encountered is liquidity.

But if somebody is interested in just a few long dated out-of-the-money calls on crude futures like Korg is (I suspect), then I wonder if liquidity is really an issue.

He'll probably hold them to expiration or he'll exercise them. I don't think he needs a liquid market because he is not day trading.

He could get hosed a bit when he takes his position but given the nature of the bet, I can't see it being a bit deal if he overpays by 10% or even a good deal more.

Hi Shawnott,

Revealing my complete lack of knoweldge, I have a q:

re: " orders didn't seem to get filled."

Could you form a co-op? (Part serious, part :)). Still, am curious if there isn't some kind of "small potatoes" group strategy already "evolved" - if not, why not?

Or, is it that the numbers are so big for the "non-limited" guys that the ballparks are on different sides of town? Or do "limited orders" come "marked" in some way that identifies them? (But this really doesn't make sense, because, why would the ones who do the filling care one way or the other?)

The trillion you got left may not be your finest half. You got some sour oil, you got offshore deep, you got extra heavy, you got oil in unstable nations. Chevron had some commercials with a guy putting a dipstick into the sand and saying half the world's oil is gone. That is some form of saying it might be downhill on the other side of the peak. High prices is the only way to bring conservation to some. The gaz guzzlers get left on the used car lot.

I think it is useful to be more precise:

One contract is for 1,000 barrels and it does worth about USD 65,000. But the margin required may vary and is not necessarily USD 4,000. I guess for someone willing to play 50-100K, this will be more like 15% margin. It is important also to state that if you make a loss on the future, your broker will do margin calls. You need then more than just USD 4,000 in the bank to play one contract.

A future is not an option: You have to fulfill your part of your contract at maturity. So you may need more cash than just USD 4,000 to play 1,000 barrels. And everytime the broker is not satisfied with your margin deposit, he requires a margin call.

On the other hand, if you make a gain on your future, then you will receive money back as your broker will be satisfied with the rest of the margin deposit.

Im confused. Do you think arbitrage doesnt exist or that it doesnt do what Nate is pointing out that it does?

a number of countries (mainly OPEC) are now saying they want to price in euros not dollars for their oil.
Oil has always been priced in dollars, and the dollar is the international reserve currency.
If OPEC and the Russians say they want Euros, this (I think) will force the dollar down, and the "price" of oil up.

Isn't this a part of what the market is implicitly saying - that the dollar will decline much more significantly and this needs to be priced in?

(obviously many other reasons for dollar decline, but did not want to get into them)

There's a wide spectrum of thought on dollar denominated oil sales, ranging from "minor issue" to "global petro-dollar conspiracy." I'm somewhere in the middle: I think that, gradually, the world will shift toward a basket of reserve currencies, and this will make the US dollar worth less and US debt more expensive. This seems to me to be one of three factors that will make the absolute price of oil (in USD) rise: decline in the dollar, inflation, production declines. These factor are all self-reinforcing: decline in the dollar will drive inflation due to the rising price of imported energy, etc. The outlier is the potential for deflation, but I think that central banks have long realized that inflation is better than deflation, and it is in their power to choose one or the other to a large degree. Our entitlement mess and debt obligations pretty well rule out the Fed electing even minor deflation over massive inflation, IMO.


sorry for OT, but....

Can you explain how you see US being able to pull out of the massive foreign triple debt, IF USD reserve position is diminished (Fed can't print more to pay the debt), foreign central banks start offloading their USD reserves (even the existing ones, not just future positions) and those loans have to be paid in the time of increasing oil imports & oil prices.

I can't seem to be able to figure it out by myself.

I see that the US would just have go to a fiscal crisis and ask World bank and IMF for big loans, except that they are bankrolling US funds :)

Then again, I never claimed to be an economist. Maybe US just defaults on their loans and says "screw you" to everybody in the world who they owe to?

Or is there some sort of a "happy ending" to all this that you can foresee?

No, I can't see how the US can pull this off. I'm cautious when it comes to expressing this concern, because I recognize the need to restrain my own "conspiracy theory" tendencies.

Personally, this is one reason why I like the oil play, even in the face of potential significant demand destruction. I think that one result will be serious drop in the dollar, and very significant inflation--this is the only way that I see to maintain the entitlemet ponzi scheme in light of this future scenario. So, while I think significant demand destruction is likely, and even that it may be enough to make the price of oil in 2007 dollars drop, I think that the future-dollar price of oil will still be way, way above where it is today. The worse the demand destruction, the more I think inflation will soar and the dollar will drop...

Honest to god, the easiest way out is bankruptcy. Start over. We have a reactive gov't (who doesn't, well we could argue) and instead of waiting for the worst, hyperinflation decades out,.....yada yada yada....we should simply declare bankruptcy now and capitalize on what this would do to the international markets. Foreign investment here is still high in spite of all the warning signals flashing across everyone's screens.

Imagine assassinating the world market so we can renegotiate all the rules (pymt to whom) - it's so American...

As much as I bash the US it is still a land with immense intrinsic wealth. I think it would give Russia a run for its money on the basis of simple resource wealth not to mention infrastructure even if some is misplaced. One way to see this is to walk through any American city and estimate the worth of its infrastructure and then do the same for farmland.

How much is the state of New York worth ?

Needless to say the intrinsic wealth of the US is mind boggling the economy is just a thin layer of percentages on top of this. If we went bankrupt we would be fantastically wealthy as a nation.

What about the fringes of the northern border, more along the lines of say the country of Canada. Don't they actually have a larger landmass than Russia, or did I misread that?

Do we know for sure that the Saudis trade futures contracts?

Maybe they avoid that game for their own reasons.

As I have previously noted, the average monthly Brent spot price in the 20 months prior to 5/05 (so far the all time EIA record month for crude + condensate production) was $38. The average monthly Brent spot price after 5/05 has been about $62, within a range of $54 to $74.

IMO, this has caused enough forced conservation in poorer regions like Africa to clear the market.

However, in a post-peak environment, forced conservation will move progressively up the food chain.

IMO, what we are presently seeing with Brent versus WTI is a bidding war for declining oil exports. Prices will continue going up until we see some forced conservation in regions like China, the US and the EU.

Then things will stabilize, and then oil exports drop again, which will start another round of forced energy conservation, higher up the food chain.

I repeatedly tried to warn anyone who would listen.

I repeatedly tried to warn anyone who would listen.

I, Asebius of Toronto, do hereby bear witness that the above statement by Wesley Texas is true in all respects.


I was reading yesterday that the media reports, especially the ones on CNBC, regarding the supposed glut of oil in storage for the past 6 months never existed, and that overall oil in storage has consistently decreased for the past 2 years. This ties in nicely with WesTexas's breakdown on price with 5/05 being the breakpoint.

The info was contained in the Mar 10 broadcast of Financial Sense. I have no idea of where or how to pull the actual data, but it would be an interesting plot against spot prices as well as some of our HL's.

IMO, Round Two of the bidding war has begun. Brent is currently above $68.

I think that Brent is dragging WTI higher (now over $66).

At this rate, we are going to blow past $3 gasoline in the blink of an eye.

"As not for whom forced conservation comes, it comes for thee."

(Apologies to Hemingway, Ruskin(?) et al)

A friend in CA who lives near Long Beach was always saying that gas was cheaper there then in the rest of CA. She reported the other day that it was 3.07 for regular, and it was 3.25 in SF. This was before the nice pop in oil price.

It's been hovering around 3.00/gal in HI for a while, and I haven't been to a station in a few weeks, but we are usually the highest in the nation in HI.

Originally it's John Donne, 1623. I think this part of the poem is particularly apt:

Another man may be sick too, and sick to death, and this affliction may lie in his bowels, as gold in a mine, and be of no use to him; but this bell, that tells me of his affliction, digs out and applies that gold to me: if by this consideration of another's danger I take mine own into contemplation, and so secure myself, by making my recourse to my God, who is our only security.

Incidentally, most people misquote the original, saying:

"Ask not for whom the bell tolls; it tolls for thee."

...but the actual quote is:

"...never send to know for whom the bell tolls..."

John Donne "No man is an Island".

"Send not to know for whom the bell tolls. It tolls for thee."


There is already a bidding war in Asia when you look at the price of Tapis as compared to WTI. It is already over $70 a barrel. Its heading for $72 and this graph attached is at 28th.

See graph 2

The spread between WTI & Malysian Tapis was about $1 up to 2005. It has over past month got out to a $9 premium.

The real action for oil is in Asia.

Westexes: I'll listen! Do these bidding wars come in cycles? when can we expect the next to break out? Is it possible to predict far out the upper range of oil -say in 2012?

As this is essentially a financial post regarding PO I would like to ask the question now what the board thinks is the likely macro-economic sequence going forward assuming we have reached PO. I have seen comments on the board regarding Inflation, Deflation, Hyperinflation...

IMO possible sequence would logically be something like:

1. PO
2. Rising spot prices
3. Inflation (+12-18months?)
4. Rising interest rates (to combat effects of 3)
5. Recession (in response to credit being more expensive)

-then not too sure after this!

6a. HyperInflation (but why if 4?)
6b. Deflation (but why if PO passed?)
6c. Lower interest rates to stave off recession (but what about 3?)
6d. Stagflation (rising prices in a recession)

Regards, Nick.

Exports, Exports, Exports

I could be wrong, but I expect the world production decline to be gradual, probably somewhere around 2% per year.

However, from the point of view of importers, IMO, this will look like a crash.

Even as production declines in many exporting countries, their cash flow will increase, at least at first--accelerating the rate of increase in domestic consumption--because oil prices will go up faster than their exports fall. This sets up a positive feedback loop in most exporting countries--at the worst possible time. For example, car sales in Venezuela are up by about 50% year over year. All of this aggravated by subsidized petroleum prices in many exporting countries.

Who know where things are headed? I think that there are two primary trends: (1) Deflation in the auto/housing/finance sectors and (2) Inflation in Energy and Food. For those who lived through the Seventies, just imagine that they never ended.

Copy of my Drumbeat Post:

The one year increase in domestic Saudi consumption was 360,000 bpd to 2.0 mbpd (Total Liquids, EIA), from 2004 to 2005, while their current crude oil production is down about 1.1 mbpd from 2005 to early 2007. It currently takes 100% of the Total Liquids production of the 14th largest oil producer in the world, Brazil, to meet domestic Saudi consumption.

Try an exponential increase in domestic consumption against an exponential decline in production. What you get in a worst case scenario is something like the UK, which went from probably peak exports of one mbpd in 1999 to a net importer in 2005, so they probably crossed the zero line in 2004. Think of it--maximum exports to zero net exports in about five years.

We won't see that in Saudi Arabia, but if, as I suspect, Russian production starts falling later this year or next year, IMO we could easily see a 50% drop in net oil exports by the top 10 net oil exporters within five years.

Keep in mind all those people getting kicked out of homes due to foreclosures.....has everyone seen this graph of resets? It's all over my finance blogs...

It should look like this one if it were normally distributed....


This is the gunshot...the warning shot across the bow or whatever they say. I've been discussing this with a lot of people and UNTIL they saw this graph, they fought me. When they saw it plain as day, they caved and wanted to know everything I knew. There is a perfect storming brewing. We've got massive internal and external debt. We've got cheap energy inputs being erased FOREVER. Those homes are getting foreclosed on and the highest rates are tied to high unemployment. The housing crash is putting how many people out of business? All those carpenters, mortgage brokers, etc will not be working.

When these people start spending less and depending on govt's for more, the margin has been set. The house comes down, we cannot expect everyone to have a job when there aren't people to pay. It's circular to a degree, but the changes happen at the margins. With a few million less people spending, the domino's start falling. We're all still connected by less than six degrees, right?

Oil will spike hard initially, but it will decline as fewer people are using oil and conservation efforts to make a dent. However, as WT has stated, it will only be followed by more increases for a dwindling supply. Marginal producers will be put out of business since they won't be able to control their costs/barrel as easily as a well capitalized company.

Stuart posted some consumption graphs a while back and there was little correlation with recessions.

Here is a paper.

From this paper we expect gasoline demand to be pretty inelastic. Also understand that people moving from a over priced house that they cannot afford to a cheaper apt will have more disposable income technically. I think most of that will be technically gone paying bills but once they have lost their credit ratings we have to assume they will continue to default on credit cards etc so they can make their rent gasoline food and car payments at the expense of all other debt.

Unless they reach the state they have no job and are no longer looking I expect gasoline consumption to stay constant at best and potentially rise if people are looking for work. Diesel consumption on the other hand may decrease as less goods are shipped. Overall I'd say people are too optimistic about price effecting gasoline demand until its well over 100bl.

Hi Tate,

I'm not really sure that the US ARM reset thing is such a big deal as is being made out. Sure for people who have basically gone out on a limb (sub-prime 'liars') it's going to be painful if not 'walk away' bad but it still only represents a small % of mortgages in the US if I have read other web posting correct. I think it's gonna take something macro-economic BIG to upset the cart (PO?)

It may prove an unexpected financial boom too -here in the UK we are all pretty much ARMed mortgage wise... For some of us every couple of years we all go out hunting for the best 2 year fixed deal -complete with a 'fee' to the provider of course -I've done it for the last 6 years. It's bread and butter turnover for the lenders...

P.S. What's a 'lifetime fixed rate mortgage' again? ;o)

Regards, Nick.

You should read more on the subject the fact that the loans are ARMs is only a small part of the problem. Wait till you go to do your bi-annual refinancing and find out your house dropped 15% in price and they want and additional 20% down
to secure the note. Lets see if it was a 100% note originally. Assume you paid 500k USD for it.

Thats 75k cash to cover the lost value.
And 85k to pay the new 20% down requirement before refinancing. And if your home just went down 15% you bet they want at least 20% down to cover and further losses.

So do you have 160k burning a hole in your pocket and don't mind throwing 75k away. Even if you put 20% down your still talking 60k to refinance back to 20% equity and you lost most of your original down payment.

Next housing prices are set at the margin i.e the latest comparable sets the price. So everyone took this hit regardless of the loan they used only the ones with high down payments are close to zero and they cannot afford to refi if they have a ARM. Basically almost everyone that bought a house with less than 30% down in the last 3 years is toast the rest just broke. For the baby boomers hoping to retire 5 or more years of equity gains are wiped out if they have HELOC's they are underwater.

Next housing is a big industry in the US so the whole time its basically in shambles driving down the economy since the industry is basically locked up until prices get back in reach. I urge you to read more on the subject. Its probably far worse then the MSM is even reporting. The last time this happened was back in the 1920's real estate boom and before that in California in the late 1800's.

Ohh btw last time it happened on anything close too this scale all the money fled into stocks propping them up for a while despite fundamentals then we hit the great depression. And those bubbles where much much smaller than our current one. And we where not facing peak oil at the same time and Baby boomer retirement. And what the heck lets throw in a little global warming to make life interesting so people in hurricane regions and flood plains insurance goes through the roof and they can't even sell their homes.

Of course its only a subprime problem.

And unlike the US homes only go up in value in the UK.
You guys are next on the list to get whacked and I assure you I'll enjoy the show.

I humbly disagree, but this morning I cannot make the time to make my case. Please check out and read some of Janzsen. He called the tech bubble before it happened and then shut his site down. He reactivated it only when he saw the massive ARM struggle coming. I agree though that simply stated we are talking about a small percentage, but here's the rub. Prices are set at the margins. The marginal cost to the entire housing stock to get these last few percentage of people into homes was immense! We have nearly doubled the entire value of real estate in this country in less than 8 years. Check the graphs, it's crazy!

Incomes are too far out whack from prices. People literally can not afford a home, who is going to buy ANYONE's home? Imagine live in a decent neighboorhood however it's 1/5 financed by arms oans. If 1/5 of those homes go up for sale at the same time, and no sub prime borrowers qualify, who is to buy these homes? I mentioned incomes are too low across the board to support home prices. We are tacking on excessive inventory already from new home builers and now we are going to dump millions more out of their old homes. How do you see this not affecting EVERYONE? When these people don't have homes, where do they go? Do they keep their jobs or lose those due to stress? We could go on and on...this is the tip to the iceberg the catalyst.


Newcomer here.

Good analysis- but I agree with the poster who asked that this analysis be validated with historical data.

Even though he suggested the 70s oil shock, and that is impossible since NYMEX didn't start until 1983, is there any comparable time bewteen then and now where you could run an analysis and see if the long-term futures acted as the "signal" you think it's acting like? Or else behaved in the way you logically think it should behave?

Otherwise, I worry you may be reading into the analysis the conclusion you think you should see...however logical it may seem.

Thanks- this place seems ver informative- think I will hang a while!

Newbie "pseudo-doomer"

welcome. Believe me, hang around here long enough and you'll learn something. :)

You learn might not like what you hear though!

I like the idea of using futures markets as a source of information, but I'm afraid I have to disagree with the reasoning and conclusion in this post. I will point to an analysis and explanation of these issues by Prof. James Hamilton, of the Econbrowser blog. Hamilton is an economist who specializes in the study of oil prices and is as good an expert as you will get on this topic.

In his blog entry:

he makes two points that contradict the analysis here. The first is that futures market prices do equal the market expectation of future spot prices. Basically, if this were not true, there would be an expected profit to be made by buying or selling the futures contract with the intention of turning it into a spot transaction at expiration. As he describes it, with the example of a trader in June considering December spot prices and the December futures contract: "In equilibrium, the expected December spot price would be forced to equal the price of the futures contract that you could buy in June."

Second, in response to a question I asked, JDH explains that there is in fact a limit on how much lower than spot prices a futures price can go, just as there is a limit on how much higher it can go. He writes, "What happens if the expected December spot is less than the June spot plus interest? Then anybody who's currently storing oil should sell it now and invest the proceeds so as to earn that interest rate on the cash rather than trying to get a capital appreciation from the oil. You'd get a higher return on your money by selling the oil now rather than storing it. If there's no convenience yield, then any time there is a positive amount of oil being stored somewhere with the expected December spot below the June spot, somebody is missing out on an opportunity for expected profit... In equilibrium, the expected December spot has to equal the June spot plus cost of carry."

This second point is less important but does clarify and correct Nate's picture of how expected future spot prices relate to present day prices.

There are several other problems with Nate's analysis, including that this "arbitrage cap" would have to be about $4/bbl over 6 years(!) in order for the current small degree of contango to be explained by his theory, but storage costs and interest costs will be far greater than this.

The bottom line remains that a market price of about $70/bbl for 2012 oil is inconsistent with Nate's position that insiders know about Peak Oil and expect much higher spot prices in that time frame. Turning Nate's hypothetical around, if Saudi Arabia had inside knowledge that there were going to be massive oil shortages in a few years and corresponding high prices, insiders could (anonymously) take positions in the futures market to lock in high prices. The effects of these trades would be to drive up futures prices, which would eventually drag up today's spot prices.

It is simply impossible for the market to believe in $200 oil in 2010 like Matt Simmons does, and to have the price structure we see today.

I believe I agree with you maybe .. not :)

Although todays spot prices are volatile based on current events. I don't quite buy into the long term futures contracts pricing in expected calamities. I don't think they can look into future that way.

I think this is what your saying ?

Nate's position is sort of crystal ball style of predicting the future the market structure itself tends to discourage this sort of prediction. Simply because you have to pick a exact time for these sorts of contracts. The trick is to convert this absolute to a probability.

Now with that said we are I think considering simple un-hedged trades so on Nates side I think he would have to show a much stronger hedged ladder of positions that cover a range of potential dates. So what you would need is someone who has set up a series of positions that cover a probability range of potential high prices.

Much more complex and harder to see with a simple market analysis but quite doable. I'd have to think major market players set up exactly this sort of hedged probabilistic sets of trades right now. Next of course these can be timed so you have multiple patterns set up beforehand and you kick them off as each one passes narrowing the hedge. Sort of a cascaded overlapped probability distribution with narrow losses or slight gains if the big play rolls forward.
In fact you can take losses to strengthen your big positions.

If I can think to do this I'm sure others can and I'm just as sure you can't see the positions since the decision points are hidden and don't unfold for a while and of course your revisiting your positions and model often to tweak it so the model is not constant.

Also if your a big player hiding your position is just as important as making it.

But since its based on hedges the fact that the overall market seems to be in slight contango can indicate some pretty big moves upward that have not yet been taken. So it indicates a possibility of people set up to move fast.

I guess what I'm saying is I'd play the market to make some easy small money/losses but set it up so I could uncover the winning hand when the time is right.

I'd guess the only clue would be volume as certain positions unfold you must watch the timing and volumes of the trades to see where they are leading and its a window on profit loss so looses are fine if they are contained. Of course other big fish are playing the market so it not disconnected.

I can't see I'm the first one to figure out how to do this.

No wonder they hire VSP's ( very smart people )


EXACTLY. The market may believe in "tight supply", but there seems to be NO INDICATION that the market believes in immediate peak and massive permanent decline in production, at least not yet.

If one compares the current $66 per barrel price of oil to the price of everything else in society over time....pick any long to housing, college education, medical care and medications, automobiles, etc, etc., and oil is just not that is simply now returning to where it should be, if you take out the long collapse price of the 1980's and most of the 1990's. Oil is, comparatively, relatively cheap. If it were not so, there are many other options that could compete with it on a technical basis, but simply cannot compete with oil on a price basis.

And by the way, this discussion of oil at $400 or $500 per barrel is to me simply beyond the pale of all reality....hell, at that kind of price, your getting to the price of hydrogen straight from sunshine, with no technical advance from where we are!! Once you get to those prices, your talking being able to almost pull energy out of thin air...

Roger Conner Jr.
Remember, we are only one cubic mile from freedom (and at $400 dollars a barrel, we can probably whip up 4 or 5 cubic miles!)


I did a quick google on "arbitrage cap" and couldn't come up with anything.

Do you have some references for us?

Nope, that's my term. Look up "Law of One Price" and you'll get plenty. I felt that using a formula that produces a max future price (law of one price) is a bit more difficult to grasp within this context than the notion of an "arbitrage cap," which is just a restatement of the same notion.


If one was betting on oil prices exceeding $2000 in X years in a highly inflationary environment, one might implicitly also be betting on a collapse of the financial system as we know it.

In other words, do you think very high-end price estimates are NOT priced into the futures? It would seem nonsensical to invest when you believe there's a good chance the institutions will not be around to deliver your returns.

Hope this makes sense... maybe I'm missing something obvious?


I think that's a pretty reasonable assumption. I don't see oil ever being $2000 (in today's dollars), or $500, and probably not even $300. I think somewhere between $100 and $200/barrel (in 2007 dollars) is the long-range point where demand destruction and peaking will balance out, but that's just a WAG.

Ok, yeah... today's dollars I'd agree. I suppose I was making some kind of wild hypothetical guess about future inflation.

This analysis has a number of problems making it very questionable in my opinion.

1) The key assumption is that the Saudis hedge in the long dated futures market. In my experience, they simply don't hedge at all. Neither does Exxon or Chevron or Shell to any extent. Their managment takes the approach that investors wish to invest in an oil company, not in a hedged oil company. It also lets them avoid taking a real position on the price of oil.

If the Saudis just don't hedge as a matter of principle, how can the futures markets tell you anything about their situation or thinking? If the author has information that the Saudis are hedging, I'd like to be proven wrong.

Moreover, the author makes the point that they have the only supply capable of setting price. why bother to hedge if you can just set the price when you get there? Not to mentin with hedges you can take a hit on basis risk.

2) there really isn't any tankage out there capable of letting the Saudis or any one else take a big position relative to the entire market. There is enough for traders to play around but not enough to change the market fundamentally.

Also tankage at US refineries relative to crude runs has been shrinking for a number of reasons:

a)to conserve working capital Management does not wish the operations people to make their lives easier at the expense of having oil just sitting around
b) The need to double bottom tanks for pollution/leak reasons. Retrofitting/rebuilding tanks was expensive so they did as little as possible.
c) the number of refineries shrank. Larger units can get buy with less tankage than a bunch of tea kettles.

The older tanks are simply gone. You can't just clean em up and start a contango storage operation.

Merchant tankage around the world is not very large. Tank farms in oddball places like St. Eustatius Or the Bahamas exist but double handling crude is expensive. The cost of rental is also not trivial. There is storage in places like Rotterdam or S'pore but not all that much.

Hence if there was really a sustained bid for 10 year out oil, it wouldn't take long to fill all the tanks. Your arbitrage cap is not that effective. Just look at last months roll over gap on WTI $3/bbl for one month!! Storage capable of delivering against WTI was as full as could be obviously.

3) The real reason the longer dated market is capped is there are no real buyers out there. The smartest airline, Southwest, doesn't hedge more than 2-4 years out. The bankrupt ones (all the rest) couldn't get credit and can't afford to pay options premium. About all they could do is zero cost collars but even then they didn't reach out all that far. Trucking companies? few years. Refiners -- not at all unless they can sell out the products to lock a margin well above spot. Pretty unlikely now with margins so high.

The biggest demand for petroleum in the US is for gasoline. This demand amounts to 10-13% of world wide crude production. When was the last time you hedged your gasoline purchases for 2012????

Who are the players down the curve? Mostly small scale producers with high costs of investment whose banks force them to hedge to protect the loans. Buyers used to be just Wall Streeters who played the market hedging their exposure via spreads to the prompter market. Hence the reversion to mean prices down the curve. Sellers had to take what Wall Street was prepared to pay. Now we have hedge funds bidding and probably taking the final exposure. That's helping keep the longer dated prices firm.

hedge funds are not real buyers. They may be able to keep the curve up, but if fundamentals turn against them, like last August when the HU contract for Sept cratered, they can all rush for the exits. They do influence and perhaps control the curve, but I don't think they tell you much about fundamentals as the real players aren't involved.

Many above are correct, there is very little usefull information to be gained from the oil futures markets in terms of the distant future months. The Saudis couldn't hedge even if they wanted to because there is not nearly enough participants in the futures market to take the other side. If the Saudi orders hit the pits, million and millions of bbl. a day, the price would crater in order to attract enough bids.

It is of course theoreticaly possible that the oil futures market could expand by attracting enough capital to absorb massive hedge selling by the Saudis but it couldn't happen overnight, it might take years. Again, that would only be if they wanted to hedge to begin with.

Futures markets don't really work in any case for distant future times, no matter what the market. The uncertainties are too great, the risks too high, to attract anything but the boldest or silliest speculators.

The ideology of market fundamentalism says that centralized auction markets, stocks, futures etc. discount all information and arrive at the 'right' price which is a distilation of all information. The invisible hand at work again. This is total BS. Such markets work mainly on the availability of money, liquidity, in the hands of speculators. When plentyfull speculative money flys around to the hot markets and bids up prices till they blow off and fall as the weak money is taken out.

Just witness last summers oil run. Peak oil was the rage. Money flowed into oil futures. While tight supplies dictated higher prices the near $70 price was generously tagged as containing a large "risk premium". Then Goldman Sachs jiggered the makeup of their futures index, downsizing the oile content, and futures index funds tied to the index had to sell oil. The rest is history. Once prices started to fall the weak late buyers were wiped out. One large hedge fund went belly up. Oil retreated to $50.

Wash, rince repeat. Since the world is awash in money in the financial sphere it's probable that another oil run is in store this summer. Pissanti's breathless interview should be seen as touting oil. CNBC is after all simply a venue for touts, shills and grifters.

None of which is to say peak oil isn't a huge issue.

Can you please explain this:

The point is, it is theoretically possible for traders to find some good reason to price oil much lower one year from now than today’s spot price. Arbitrage has no mechanism to correct this disparity—you can’t buy a future contract to cover a sale of oil today.

Why can't you buy a future contract to cover a sale of oil today?
Lots of companies have stocks (full months of consumption, in OECD countries).
I would expect that, if the prices are tempting, they can sell some of those stocks today and buy futures contracts to guarantee they recover those stocks at a predefined future date...

you cannot buy a future's contract to cover a sale today because there are no time machines. The idea of a futures contract is that it ensures delivery of physical oil at some later date. You can't buy the future to cover today's needs. And some futures contracts are cash settled anyway so they don't even guarantee physical cover of your needs.

What you are proposing is selling physical that you already have today and buyin futures to cover later needs. That is obviously possible if you happen to be long un-needed bbls.

Really think you are just getting the semantics off a bit.

Clearly no one would do this on WTI at the moment. The cash is way below the futures so you'd be selling low and buying high.


Thank you for your piece. I agree with many of your premises, but disagree with one important conclusion, and wondered if you could comment.

I agree that the maximum premium of future oil over spot oil is constrained by storage cost + time-value of money. I also agree with your important assertion that spot price is set by supply and demand for oil (not for oil contracts), and therefore, the spot price can only be speculative to the extent speculators are able to remove real oil from the marketplace. So while easy storage enables lots of speculation in precious metals prices, for example, the only possible speculators in the spot oil price are those with the ability to store oil.

However you seem to assert that this means that only the spot price can drive the futures price, and not the other way around.

Couldn’t futures price can also pull up the spot price, as follows?

If the expected future price is high enough, then the price of oil would have to rise fast enough between today and the future that oil in the ground pays a higher return than money above ground. In that case, it pays to leave the oil in the ground, postponing production to get a higher price in the future. This reduces spot supply, until the relationship between spot and future oil once again restores the “arbitrage cap” relationship you identified, but by pulling up spot price, as opposed to pulling down futures prices.

Much of the Oil Drum dialog has focused on whether the Saudis are peaking or making voluntary cuts. Doesn’t the dynamic I’ve described suggests these don’t have to be mutually exclusive? Once spare capacity no longer exists in oil production, voluntary cuts could be economically rational.

what you are proposing is correct but if you leave the oil in the ground, the premium of future over spot is just the TOM. as there is no storage/handing costs.

The MAXIMUM should be spot + double handling charges + storage +TVOM. The point is the max spread between then and now, not how high the entire complex can be lifted.