Using the Futures Strip as an Indicator of Future PricesThis is from this morning’s TDSI Morning Action Notes;
Using the Futures Strip as an Indicator of Future Prices
Analysis Suggests a Poor Track Record and Above-average Volatility
TD Investment Conclusion
There is no doubt that doom and gloom has engulfed the energy complex, exacerbated
by heightened volatility, particularly around WTI crude oil prices. Rather than
debating on where commodity prices could actually go, we look into the historical
track record of the futures strip’s accuracy as a predictor of spot prices. Our base
assumption compares monthly spot prices since 2001 relative to average expectations
over the 24 months leading up to it. We find that not only is the strip a weak
indication of future prices, but the above-average volatility associated with rising (and
falling) oil prices means that there could be any number of scenarios that actually take
place. To this end, we provide a summary of corporate cash margins and debt for the
Junior and Intermediate space (under the current futures price) in order to assess
which names stand to benefit the most from an increasing oil price.
In summary:
1. The futures strip has historically been a poor indicator of spot price realizations.
For the 175 months underlying this analysis since January 2001, the future strip
overestimated the actual price 56 times (i.e., 32%) and underestimated the actual
price the remaining 119 times (i.e., 68%). Although WTI has recently shown to
be highly correlated to the global supply/demand imbalance, this has historically
not been the case.
2. Extremely high volatility relative to historical levels leaves plenty of room for the
strip to be wrong about 2016 or 2017 oil prices. The standard deviation of the
July 2015 contract over the past 24 months was US$15/bbl, relative to something
on the order of US$7/bbl for the 2011–2014 period. With the current spot price
more than two standard deviations lower than the strip would have predicted, it is
not without reason that the current futures curve could be overly punitive.
3. With the current market sentiment at a recent low, and 2016 futures prices
reflecting $49.50/bbl WTI and $3.05/mcf Nymex Natural Gas, we look at cash
margins as a gauge for which names stand to benefit from a rise in commodity
prices given the high levels of volatility discussed above. Obviously, a rising tide
will lift all boats, but the stocks that stand to benefit the most from a cash flow
perspective, in our view, are those that have more than 20% liquidity on bank
lines, below-average cash margins, and more than 70% weighting to oil. In
alphabetical order, these names are BTE, LTS, PXX, SGY, TBE, and ZAR.
As Always; Do Your Own Due Diligence; It’s Your Money !!