Energy Markets Avoiding the Panic

I'm forever blowing bubbles
Pretty bubbles in the air
They fly so high, nearly reach the sky
Then like my dreams they fade and die.

-- Jaan Kenbrovin, John William Kellette

Generals fight the last war, investors chase the hot stocks, and as anyone who had the misfortune of enduring an airport line over the recent holiday season can attest, the overwrought Transportation Security Agency is going to spend billions of dollars making sure Sept. 11, 2001, won't be duplicated. Memo to the TSA: When you build a 10-foot wall, someone will build an 11-foot ladder.

Such is human nature. After Watergate, every two-bit political misstep got a "gate" appended to it, and now every bullish move is described as a bubble. Haven't we already endured a real estate bubble and a bond bubble in the last six months? I don't know about you, but I don't feel worse for the wear.

Bubbles don't sneak up on anyone. They arrive with fanfare, replete with warning signs for the unwitting, and they often provide statistical clues about their degree of overvaluation.

These thoughts crossed my mind on Jan. 2, when the strong rally in stocks was accompanied by an even more breathtaking leap in natural gas prices: The February contract jumped by 9.65%. The catalyst for this move, as long as you are asking, was a forecast for cold weather in January, as unthinkable as that may be.

No Bubbles Here

The crude oil market has been putting on some mileage in both directions of late. The risk of war in Iraq hasn't taken any barrels off the world market yet, but the oil workers' strike in Venezuela has taken nearly 2.5 million barrels per day out of the supply stream.

The Venezuelan problem will be solved in due course, quite possibly with an unhappy ending for President Hugo Chavez, while the Iraqi situation will continue to drag on like some dermatological condition. Let's measure what these two in combination have done to the oil market's anxiety levels.

The quick answer is "not much." In a prior life as a commercial hedger, I developed three different measures of a commodity market's buying or selling pressure. These were linked together to form the proprietary Market Tension Index discussed in Chapter 5 of the book referenced in this article's footnote.

The most important two of these measures, the shape of the forward curve and the option market's excess volatility premium, aren't flashing any sort of buying panic signals at the moment. The shape of the forward curve is described most properly with a measure called "convenience yield," or the implied yield on storing excess inventory. However, we will use the simpler "backwardation," or premium of the first delivery month of crude oil futures relative to the second month, expressed as a percentage of the first month's price.

No Buying Panic

Source: CRB Infotech