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TheStreet Open House

Another Sign Oil Prices Don't Reflect Reality

NEW YORK (TheStreet) -- Why are crude oil futures for delivery three years from now $30 cheaper, or almost $1 a gallon less, than current oil prices?

That just doesn't seem possible, unless the oil trade is totally overrun with speculators and Fed-inspired cheap-money investors.

On CNBC on Friday, I got into a discussion with an executive at one of the larger derivative brokerages about the amount of speculation and investor interest in the oil markets today.

He made a number of good points, but one that wasn't so good was his comparison of the oil market to the stock market. He claimed that current oil prices reflected risk in the market accurately because they are "forward-looking."

That's an old saw for equities traders. It posits that stocks can react today to events and cycles that are still many months away. The equity market can be "forward-looking" and price in news that hasn't happened yet but is expected to happen.

But futures are not like stocks.

For any company, there is one primary instrument to trade: its common shares. But with oil futures, you have a multitude of monthly deliveries -- and you can trade any of them at any time.

In other words, futures don't need to be forward-looking. They are in fact real forwards -- with an expiration date attached to every investment or hedge you choose.

If you want to bet that an event will happen that will affect oil prices three months from now or three years from now, you need not buy physical "oil" or today's closest month to delivery. You can buy or sell oil that delivers exactly when you think that event will occur.

Most investors probably don't even know this.

But it is more than telling that futures for delivery in December 2015 Brent crude oil traded at the IntercontinentalExchange (ICE) are almost $30 lower than the current spot price.

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One of three things is going on here.

Either all of the oil analysts who are talking about increasing emerging-market demand and dropping marginal supplies and continual long-tail geopolitical risks over the next several months and years are all wet.

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