I noted back in mid December that oil was looking extremely and unsustainably oversold at well under $40, despite the $25 2009 forecasts from the same oil analysts who thought $150 oil was justifiable on fundamentals a few months ago. That's proved a good trade, with most grades rising 25-30% since, with the exception of near delivery WTI, which is being technically depressed by a shortage of storage at its Cushing, Oklahoma delivery point (only about 1m barrels of storage left). Much media comment uses WTI as a shorthand generic price, but that is particularly misleading.

The difference between the price of WTI crude for immediate delivery and the one-year forward contract yesterday widened to over $21 a barrel, the largest difference since US oil futures started trading 25 years ago. while the WTI/Brent spread reached $9, the widest in 17 years. The Mars blend is trading $1.5 above WTI (amazing considering it is a medium-sour crude) while Light Louisiana Sweet is trading as much as $8.30 per barrel more than WTI. In other words, Nymex crude has cheapened dramatically versus the oil market in general due to its unique storage/pipeline constraints. Until the Cushing situation is resolved (unlikely given the steep contango in WTI (the price of oil for delivery December 2009 is 55 percent more than for February, allowing traders to profit if they have the ability to store crude. This rising price curve structure is known as contango). The Nymex light sweet crude contract remains deceptively weak relative to the broader oil market. If a volume and grade weighted international oil price existed, it would be just shy of $50 right now, pretty much where Brent is trading. So where to now?

Near term fair value is $50-60, just below the marginal cost of new capacity and the OPEC target price of about $70. Energy is clearly in a bear market that will last until we see the shape of an eventual economic recovery in 2010 and beyond. OPEC has just predicted that consumption of its crude will shrink 1.4 million barrels a day to 29.5 million barrels a day or 720k barrels less than it predicted just a month ago. They also shaved estimated world oil demand for the year to 85.66 million barrels a day. As Saudi is targeting $75, and has recently decided to cut production well under it's recent lowered quota (and China is building strategic stocks) it's hard to see the more bearish price forecasts being realised without even weaker growth than the global recession already being discounted. Prolonged, steep contango in the oil market is unusual, as deep discounts in the front-month crude contract usually encourage refiners to buy more prompt crude to turn into product. While recession has blunted that process, sooner or later it will resume ie it will be a good trade to short Brent and go long WTI to arbitrage the huge disparity.

Meanwhile, I still like long-term energy exposure via blue chip production companies globally and related specialist funds. These are worth buying on inevitable panic dips in the broader equity markets and indeed the oil price during 2009. When demand recovers even a little in response to lower prices (and already SUV sales in the US are picking up marginally), with so much planned non OPEC production having been shelved as a result of the credit crunch/price crash, we will see $100 plus again fast and possibly as soon as mid 2010.