Oil $200 Options Rise 10-Fold in Bet on Higher Crude
By Grant Smith
Jan. 7 (Bloomberg) -- The fastest-growing bet in the oil market these days is that the price of crude will double to $200 a barrel by the end of the year.
Options to buy oil for $200 on the New York Mercantile Exchange rose 10-fold in the past two months to 5,533 contracts, a record increase for any similar period. The contracts, the cheapest way to speculate in energy markets, appreciated 36 percent since early December as crude futures reached a record $100.09 on Jan. 3.
While analysts at Merrill Lynch & Co. and UBS AG say the slowing U.S. economy will lead to the biggest drop in prices since 2001, the options show some traders expect oil to rise for a seventh straight year. Demand will increase 2.5 percent in 2008, according to the International Energy Agency. U.S. inventories fell to a three-year low on Dec. 28. Production from Mexico is declining and Saudi Arabia is behind schedule in opening its newest field.
``One hundred dollars a barrel is actually 14.9 cents a cup, so we're still talking about oil being remarkably cheap,'' said Matthew R. Simmons, chairman of Simmons & Co. International, a Houston-based investment bank that focuses on energy. Inventories ``are tight as a drum and I don't see how we get out of this box,'' he said in a Bloomberg television interview last week. ``Demand clearly isn't starting to slow down.''
World consumption will rise to 87.8 million barrels a day this year, 2.1 million more than in 2007, or about the same amount that Nigeria supplies, according to the Paris-based IEA, an adviser to oil-consuming nations. Demand from China alone will increase 5.7 percent to 8 million barrels a day as imports expand to support an economy that's likely to grow 11 percent, the IEA said.
Oil suppliers are straining to increase production. Saudi Arabia, the world's largest exporter, said last week that the 500,000 barrel-a-day Khursaniyah oilfield missed a December start date. Brazil's Tupi field, the second-largest find of the past two decades, lies more than eight kilometers (five miles) below the ocean surface and will take at least five years to develop.
Petroleos Mexicanos, Mexico's state oil monopoly, suffered a three-year, 40 percent decline at its Cantarell field, the world's third-largest. Fighting in Nigeria reduced production 11 percent since December 2005 to 2.18 million barrels a day, according to data compiled by Bloomberg.
Speculators don't require prices to rise all the way to $200 to make money from options since they can sell the contracts on to others as their value rises. Nymex oil futures for February delivery were worth $97.41 a barrel in electronic trading at 11:11 a.m. London time, down 50 cents. December futures were at $93.59.
Crude futures rose 2 percent in the first three trading days of the new year. U.S. crude inventories fell to a three-year low of 289.6 million barrels on Dec. 28, according to a Jan. 3 Energy Department report.
``We haven't got to $100 on just a whim,'' said Paul Horsnell, head of commodities research at Barclays Capital in London. ``This is at heart also about longer-term concerns that supply capacity investment needs higher prices to keep up with demand growth.''
Barclays forecasts oil will average $87.40 a barrel this year, a 21 percent increase from the 2007 average.
The Nymex options, which give speculators the right to buy 1,000 barrels of oil in December, are becoming a favorite for traders even if they don't expect crude to reach $200 because they are a cheaper way to speculate than using futures contracts. Options expire worthless if crude fails to reach the ``strike'' price. There were 500 of the options on Nov. 7.
The price of the options rose as high as $550 last week before closing at $300 on Jan. 4. That amounts to 30 cents a barrel. The December futures to purchase 1,000 barrels in December rose 3.5 percent to $94,010, or $94 a barrel.
``The most common analogy used to describe options is that it represents insurance'' against ``low probability'' events, said Tim Evans, a Citigroup Global Markets Inc. energy analyst in New York.
Oil forecasters say there's no chance of $200 crude, as the U.S., which consumes a quarter of the world's oil, slows. Prices will average $78 a barrel this year, 20 percent below the current level, and $75 in the fourth quarter, according to the median forecast of 27 analysts surveyed by Bloomberg. The last time prices fell that much was in 2001, when they dropped 26 percent.
Merrill Lynch and Morgan Stanley in New York expect the U.S. economy, the world's largest, will slip into recession this year. The jobless rate rose to 5 percent in December, the highest in two years. The Institute for Supply Management's factory index fell to the lowest level in almost five years in December.
The U.S. probably expanded 1 percent last quarter, and gross domestic product will grow 2.3 percent in 2008, according to the median estimate of 63 economists surveyed by Bloomberg.
Oil is overpriced, given the outlook for the economy, said Jan Stuart, an analyst at UBS AG in New York. He forecasts an average price of $74 a barrel this year, little changed from 2007. Merrill Lynch's Francisco Blanch predicts $78 in the fourth quarter.
``I am afraid that we are going to see an economic slowdown that we have not seen the beginning of yet that will take some significant amount of oil demand off the table,'' Stuart said in a Bloomberg television interview Jan. 2.
Most strategists didn't foresee last year's 57 percent gain. Crude traded at an average of $72.36 in 2007. A Bloomberg survey of 29 analysts in September 2006 forecast a median price of $64.
``Going through $100 means that people are seeking more protection against a higher number,'' said Michael Lewis, a strategist at Deutsche Bank AG in London. Deutsche Bank expects oil to fall to about $80 a barrel.
Options trading indicates that the likelihood of crude reaching $125 a barrel in December has almost doubled since Dec. 25, to 18 percent, Lewis said.
While $200 may remain an outside chance, Simmons at Simmons & Co. showed he's willing to make that bet. He wagered $5,000 with New York Times columnist John Tierney in August 2005 that oil would average at least $200 a barrel in 2010.
The latest assessment from OPEC, which produces 40 percent of the world's oil, suggests prices will rise.
``There is enough oil in the market,'' Chakib Khelil, the current president of the Organization of Petroleum Exporting Countries, told reporters in Algiers two days ago. Khelil, who is also Algeria's energy minister, said rising prices aren't OPEC's fault. The group is scheduled to meets on Feb. 1 in Vienna.
``You will see even $200 oil in the next five years,'' said Jean-Francois Tardif, senior portfolio manager at Sprott Asset Management Inc. in Toronto.
The following table shows the median, mean, high and low estimates for the average price of Nymex crude oil futures during the four quarters of this year and the yearly averages for 2008 and 2009. The estimates from 27 analysts were compiled by Bloomberg.
Nymex WTI Crude Oil Futures Forecasts
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Grant Smith in London at
Last Updated: January 7, 2008 06:12 EST