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Crude
Oil Prices. WTI crude oil
spot prices averaged $75.34 per barrel
in June 2010 ($1.60 per barrel above the
prior month’s average), close to the $76
per barrel projected in the forecast in
last month's Outlook. EIA
projects WTI prices will average about
$79 per barrel over the second half of
this year and rise to $84 by the end of
next year.
Energy price forecasts are highly
uncertain, as history has shown. WTI
futures for September 2010 delivery for
the 5-day period ending July 1 averaged
$77 per barrel, and implied volatility
averaged 35 percent. This made the
lower and upper limits of the 95-percent
confidence interval $60 and $98 per
barrel, respectively.
Last year at this time, WTI for
September 2009 delivery averaged $70 per
barrel, and implied volatility averaged
44 percent, rendering the limits of the
95-percent confidence interval $52 and
$95 per barrel.
The occasional bouts of oil-price
volatility and headline-grabbing news
notwithstanding, the second quarter of
2010 ended not much different from the
first. Futures prices for August 2010
to December 2011 were, on average, about
a dollar higher by the end of the second
quarter (Figure 1).
Most of the increase in
the average futures prices during the
second quarter was apparent in the
deferred contracts, where press and
analyst reports indicated market
participants were pricing the impact of
the 6-month deepwater drilling
moratorium announced by Secretary
Salazar on May 27 (Figure 2).
Implied volatility also
ended the second quarter not much
changed from first-quarter levels,
albeit with occasional spikes during the
April-June 2010 period (Figure 3).
An overall firming of
the market was apparent in the behavior
of WTI timespreads (i.e., the difference
between a prompt-delivered WTI futures
and a deferred contract), which are
sensitive to storage conditions at
Cushing, Oklahoma, the location of WTI
futures physical deliveries (Figure
4). As storage levels are
drawn lower, the timespreads narrow as
storage holders sell from inventory.
The opposite happens when demand for
prompt-delivered crude is less than the
supply of prompt-delivered crude. In
such a market, a refiner without an
immediate need for crude oil must
account for storage costs, which will be
incurred until the crude is needed, so
he will bid less for the prompt barrel
relative to the deferred barrel. This
results in a “contango,” in which prompt
prices are less than deferred prices.
The price difference allows the refiner
to buy the prompt barrel and sell a
futures or forward contract for deferred
delivery at a cost that covers his
all-in carrying cost.
In addition, WTI-Brent
spreads, which are closely tracked by
market participants to gauge whether
transporting North Sea Brent and other
grades of crude oil to the United States
for refining is economical, firmed
toward the end of the second quarter (Figure
5). This indicates market
participants may be anticipating the
need for additional imports – e.g., if a
trader sources barrels offshore (e.g.,
in the North Sea), he will need to sell
a futures or forward contract for
deferred delivery to cover the transit
of the crude. To avoid the risk of loss
the trader will, in this example, price
the prompt physical barrels in the North
Sea at a discount to the barrels sold
forward so that the costs of the vessel
transporting the oil (including
insurance, inspection, etc.) are
covered. The market signals its need
for imported barrels by bidding the
price of domestic crude over the cost of
comparable crudes that can be imported.
Market participants
lowered the probability of WTI trading
at a price higher than $100 per barrel
at the end of this year by the end of
the second quarter versus first-quarter
assessments. However, by mid-2011 and
December 2011 the market was pricing a
roughly 1-in-4 chance of WTI trading at
over $100 (Figure 6).
Overall, the market’s expected
probabilities for next year ended the
second quarter in line with where they
ended the first quarter of the year.
The forward curve to December 2015 also
ended the second quarter close to its
first-quarter level (Figure 7).
Last year at this time,
WTI for September 2009 delivery averaged
$67.54 per barrel, and implied
volatility averaged 47.47 percent. The
lower and upper limits of the 95-percent
confidence interval were $49.26 and
$92.60 per barrel, respectively.
U.S. Natural Gas Prices.
The Henry Hub spot price averaged $4.80
per MMBtu in June, $0.66 per MMBtu
higher than the average spot price in
May . The forecast price for the second
half of 2010 averages $4.68 per MM Btu,
$0.32 per MMBtu higher than last month’s
Outlook. The risk of hurricane
outages and the projected reduction in
drilling activity combine to strengthen
prices through the year. A small decline
in U.S. production alongside increased
consumption leads to higher prices in
2011; the projected Henry Hub spot price
averages $5.17 per MMBtu.
Uncertainty over future natural gas
prices is lower this year compared with
last year at this time. Natural gas
futures for September 2010 delivery for
the 5-day period ending July 1 averaged
$4.77 per MMBtu, and the average implied
volatility over the same period was 53
percent. This produced lower and upper
bounds for the 95-percent confidence
interval of $3.16 and $7.18 per MMBtu,
respectively. At this time last year
the natural gas September 2009 futures
contract averaged $4.00 per MMBtu and
implied volatility averaged almost 76
percent. This rendered the lower and
upper limits of the 95-percent
confidence interval at $2.25 and $7.14
per MMBtu.
Natural gas prices trended higher
during the second quarter (Figure
8). April marks the beginning
of the natural gas injection season, and
during the April – October period market
participants are weighing the likelihood
gas storage injections will be
interrupted by hurricanes or supply and
demand shocks. On June 29, the U.S.
National Hurricane Center issued a
hurricane warning for the coast near
the Texas-Mexico border around the mouth
of the Rio Grande, where the first
hurricane of the 2010 season (Alex) was
due to make landfall.
As was the case in May
2010, implied volatility for options on
October natural gas futures, at 57
percent per annum, registered the
highest level of the natural gas futures
contracts traded on the New York
Mercantile Exchange (NYMEX). The
September 2010 contract was the next
highest implied volatility, at 54
percent. During the 5-day period ended
June 30, September futures averaged
$4.86 per MMBtu, which made the lower
and upper limits of the 95-percent
confidence intervals $3.16 and $7.47 per
MMBtu, respectively. At this time last
year, September natural gas futures
averaged $3.77 per MMBtu and implied
volatility averaged 76.6 percent. This
rendered a lower and upper limit for the
September 95-percent confidence interval
of $2.14 and $6.65 per MMBtu,
respectively.
Statistically, hurricane activity
peaks in September, when the NYMEX
October futures contract is pricing for
delivery into Henry Hub, Louisiana.
October also marks the end of the
natural gas injection season. This
tends to give the October contract the
highest expected and realized volatility
of the injection season (Figure
9).
For the upcoming winter
season, market participants assigned
approximately a one-in-three chance to
natural gas futures trading at a price
over $6 per MMBtu in the December 2010 –
February 2011 period as the second
quarter drew to a close (Figure
10). The likelihood of natural
gas trading over $8 per MMBtu is less
than 10 percent, based on market
expectations.
The probabilities in
Figures 6 and 10 are cumulative normal
densities, showing the market’s
assessment for various price outcomes in
2010 and 2011.
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