through 2100.
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How Much Oil Is There?No one really knows how much oil remains in the ground. However, ‘‘proven reserves’’—defined as the amount of oil that can beeconomically recovered—is not even the complete picture. In thefuture, higher prices are likely to expand the levels of what is economically recoverable, just as lower prices make it less viable tospend money. No oil company or OPEC member is going to spendmore money to extract oil than it can get for selling that oil to itscustomers. Futures traders may not always be aware of the distinction between ‘‘proven’’ and ‘‘total’’ reserves, but the price of oil
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affects the proven reserve numbers every year. On a more cynicalside, observers have been dismayed by the fact that improved fuelefficiency leads to increased auto use, and that means more oil consumption. The picture for long-term energy futures prices is verybullish, especially considering that no effective scenario is on thehorizon. In the future, it may be possible to run cars on cleanburning fuel, liquid hydrogen, or solar power. But today, the hybridmodels of autos may contribute nothing to the solution, and couldeven lead to more fuel usage, not less.Table 9-2 summarizes the known world oil reserves and production levels of the most active nations. The estimated supply interms of years is based on current usage; however, it is clear fromthis real-world summary that the potential reserves of oil are farfrom depletion.It is quite revealing that of total reserves, nearly three-quartersare held by OPEC countries (787 out of 1,059 in billions of reserves, based on the data in Table 9-2). These summaries demonstrate that based on what we know today, we have left at least 40to 50 years of crude oil supply. And Oil and Gas Journal has compiled data indicating that supplies are likely to grow by another 730TABLE 9.2. OIL RESERVES AND PRODUCTION
CountrySaudi ArabiaCanadaIranIraqKuwaitUAEVenezuelaRussiaUnited StatesMexico
Reservesa(109 bbl)
Production(106 bpd)
Reserve life(years)
260179136115999780602112
8.82.73.72.22.52.52.49.54.93.2
8118210114310810791171210
Estimated reserves in billions (109) of barrels (bbl). (Source: Oil and Gas Journal, January2007)bProduction rate in millions (106) of barrels per day (bpd). (Source: U.S. Energy InformationAuthority, September 2007)cReserve life in years, calculated as reserves/annual production.a
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billion barrels of proven reserves plus yet to be discovered reservesof 938 billion barrels. That is a lot of oil. Factors adding to theoptimistic estimates include improved oil recovery technology, pastdiscovery rates, and improved exploration technology. With theseestimates in mind, the world has about 100 years of known oil reserves available. Oil sand reserves double this to another 100 to125 years of supply; and oil shale reserves, estimated by the International Energy Agency at over 3.5 trillion barrels, could add another 100 to 115 years of supply.From an energy futures trading perspective, a plentiful supplyof oil reserves could imply that prices are too high, supplies areplentiful, and demand is eventually going to weaken. But realityand perception are not always on the same level of reality. There isa tendency among traders and also among people in general to seethings in dire terms. The global warming advocacy community hascited the impending demise of oil (based on updated Hubbert’sPeak estimates) as added proof that the world is 10 to 20 yearsaway from self-destruction. The numbers prove otherwise, but futures prices are likely to remain more responsive to widely heldbeliefs and fears, and less based on actual fact.
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Futures Contracts on EnergyThe high volume of interest in energy products makes futures trading in oil the highest of any commodity. The light sweet crude contract is the best known and most widely traded. Light sweet andBrent crude oil are both worth mentioning. In addition to crude oil,four additional futures trades are also worth tracking: unleadedgas, heating oil, natural gas, and propane. The following figuresshow charts for each of these futures contracts as of late December2007: Figures 9-4 (light crude—March 2008), 9-5 (Brent crudeoil—March 2008), 9-6 (unleaded gas—monthly), 9-7 (heatingoil—March 2008), 9-8 (natural gas—March 2008), and 9-9 (propane—March 2008).The price history of crude oil has been volatile, due not only tothe supply and demand of the market, but also to geopoliticalchanges and threats. The oil embargo of 1973, which halted shipments of oil to the Western countries in retaliation for support of
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FIGURE 9.4. LIGHT CRUDE OIL—MARCH
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Israel in the Yom Kippur War, caused prices to soar above $100per barrel (inflation-adjusted for 2008 price levels). This led tolong gas lines, double-digit interest rates and inflation, and overallglobal tensions. These did not ease until after 1980, when the embargo had been lifted and Middle East tensions quieted down. Inthe 1990–1991 invasion by Iraq of neighboring Kuwait, fast actionby the United States ended the invasion, but oil prices rose alongwith the tension. Even with periodic increases in oil productionamong OPEC countries, concerns about greater demand and perceptions of a dwindling worldwide supply add to ever-growing oilprices. Developing countries—notably China—add to the overalldemand, further pressuring oil and futures prices upward.Besides crude oil and its derivatives, any emerging markets foralternative energy also trade in futures. Biodiesel and ethanol areamong the most promising of the non–fossil fuel sources. Ethanol is
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FIGURE 9.5. BRENT CRUDE OIL—MARCH
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controversial, however. Current cost of production makes it moreexpensive than crude oil and it also drives up food and feed prices.Ethanol can be manufactured from numerous agricultural products,the most popular being corn and sugar. In Brazil, sugar cane–basedethanol is used widely, and in the United States the trend is morelikely to focus on corn, due to growing patterns and climate. However, widespread use of these agricultural products directly affectsfutures value of both sugar and corn, anticipating near-term increases in food and livestock feed prices as well. The December 2007contract for March ethanol traded as shown in Figure 9-10.Biodiesel is derived from vegetable oil, including soybean, canola, and palm oils. This product is used as a substitute for homeheating oil and diesel fuel. But just as ethanol affects the prices ofcorn and sugar, increased demand for biodiesel will have a similareffect on the vegetable oil used in its production. Additional re-
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FIGURE 9.6. UNLEADED GAS—MONTHLY
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search continues into additional agricultural-based uses, includingproducts not used so widely as food and feed sources not widelyused directly for food. These include potential fuel developmentfrom corn stalks, switch grass, and hay.Chapter 10 covers another large futures industry, grains andoilseeds. Agricultural products are crucial to the United States aswell as import and export partners, and a lively and complex futuresmarket reflects this reality.
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Notes1. R. J. Pirlot, ‘‘The Time Is Now: Tap Arctic Oil Reserves,’’ Wisconsin Manufacturers & Commerce, www.wmc.org, also citing data from www.anwr.org.2. EIA, Annual Energy Outlook 2006, February 2006.3. M. King Hubbert, ‘‘Nuclear Energy and the Fossil Fuels,’’ Spring Meeting ofthe Southern District, American Petroleum Institute, March 7–9, 1956.
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FIGURE 9.7. HEATING OIL—MARCH
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FIGURE 9.8. NATURAL GAS—MARCH
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FIGURE 9.9. PROPANE—MARCH
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FIGURE 9.10. ETHANOL—MARCH
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 19997.
C H A P T E R
1 0
AGRICULTURE
A
broad range of agricultural products accounts for a very active volume of trading in U.S. futures markets. This segment includesgrains and oils in nine major categories: corn, wheat, rice, cotton,oats, soybeans, Western barley, canola, and lumber.Lumber is included in the agricultural segment because it isgrown and harvested; and it is replenished by replanting. The majority of agricultural products serve as food and feed, and lumberis the one exception to this. The complexity of agricultural futuresmakes this segment especially interesting. It cannot be viewed inisolation. For example, corn and oats affect futures prices in othermajor futures segments. Both are used as feed for cattle, so thelivestock segment is going to rise or fall as corn and oat priceschange. In addition, with increased interest in development of ethanol as an alternative fuel, corn has found a third demand. Besidesfood and feed, corn is also the base crop for ethanol in the UnitedStates. In South America, sugar is the preferred crop, and differentclimates account for the difference in the two regions. This chapterdescribes the broad markets and uses for each of the agriculturalcommodities, and provides price charts as of the end of December2007 for March 2008 contracts.170
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171
CornThe corn crop is one of the most significant, not only in the UnitedStates but worldwide. Four states—Iowa, Illinois, Nebraska, andMinnesota—grow more than half of the entire U.S. corn crop. Additional states—Indiana, Ohio, Wisconsin, South Dakota, Michigan, Missouri, Kansas, and Kentucky—are added to the four majorstates to form what is known as the U.S. corn belt.The United States is also the largest producer of corn in theworld. Exported corn—about one-fourth of all corn grown in theUnited States—is used primarily as livestock feed, and the PacificRim region—where a majority of humans live—is the fastest growing market for U.S.-grown corn. The uses of corn as food and feedare only the most obvious and recognized uses. Within the foodgroup, corn has multiple uses. As a starch, corn is used in food aswell as in production of drugs, cosmetics, and industrial manufacturing. Industrial uses include development of adhesives, batteries,bookbinding, cleaners, coatings, dyes, fireworks, crayons, chalk,cardboard, plastics, refinery of oil and ore, lubricants, paint, wallpaper, tires, surgical dressings, and textiles.Corn is used for various food products, not only well-knowncorn products such as corn on the cob and canned corn, but alsoin baby food, bakery products, beer, chewing gum, confections,powered sugar, pancake mix, flour, mustard, pudding, salad dressing, soup, pet food, and sauces.Corn used for drugs and cosmetics include antibiotics, aspirin,body lotion, drug coatings, lipstick, makeup, soaps, and cleansers.Corn also is applied in creation of dextrose, crystalline sugarmade from corn starch and enzymes. Also called corn sugar, dextrose has many industrial uses, including amino acids, adhesives,dyes, enzymes, biodegradable products, leather tanning, lysine,paper, rubber, and textiles.Another variation is corn syrups, which are applied not only tofood products but also to industrial applications such as ink, dyes,rayon, shoe polish, and metal plating. Corn also is essential forsolubles, made from water and softened corn. The resulting steepwater is needed for production of antibiotics, chemicals, pharmaceutical drugs, and yeast. On the industrial side, solubles are used
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Classifications of Futures
to make chemicals, insecticides, varnish, rubber substitutes, andlivestock feed. Food solubles include cooking oil, margarine, mayonnaise, salad dressing, and snack food products. Protein and fiberdeveloped from corn include animal feed from gluten meal. Cornfiber is also used to manufacture gluten feed for beef and cattlefoods. Corn germ is also used for animal feed, and germ is alsoconverted to corn oil.Corn has so many uses that it would be difficult to imagine theoverall effect on so many products if the corn crop were reduced.The cost of corn will rise as ethanol uses continue to expand, however. This means that all of the food, industrial, and other applications of corn products may suffer higher prices in the future due tomore and more corn crops being used for fuel production. Cornprices are also affected directly by direct causes:• The availability of other livestock feed commodities, such as soymeal and wheat• Loans and subsidies from the government• Weather, especially dry spells• The harvest size of corn crops in Argentina and Brazil as well asother export rivals• The count of the livestock and poultry market for which corn isused as feedThe corn futures chart for the March contract is shown in Figure 10-1.Note the strong uptrend between October and December. During this period, oil prices were rising and approaching $100 perbarrel, aggravated by Middle East tensions. During this period, interest in production of ethanol was very much in the news. Thesekinds of trends demonstrate that corn prices are subject not only todemand for food and feed, but also by the potential energy shortages, whether real or perceived, that have so much impact on theU.S. economy.The RSI approached the overbought mark toward the end of thisperiod, indicating an overvalued condition. Additionally, MACD alsoshowed an upward momentum. Technicians would be inclined to seethese trends in a bearish way, and anticipate a price decline. How-
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FIGURE 10.1. CORN—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
ever, the added ethanol factor could have a bullish effect on cornprices, depending on the extent of production, tax credits, and food/feed prices as the ethanol debate moves forward. The price of oil isalso a factor directly influencing corn prices. For example, if oilprices were to decline, that could soften the demand for higher volume of ethanol production, softening the demand for corn as well.As with all commodities, the spectrum of market influenceswork together to determine price direction. Corn, more than mostcommodities, has so many applications within the agricultural sector and in others (livestock and energy), that price trends are especially difficult to anticipate. There are many variables.
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WheatSecond in growth volume only to corn, wheat crops are among themost important in the world. Wheat grows worldwide and in several varieties. It is a staple food for making flour, bread, cookies,
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Classifications of Futures
noodles and other pasta, cakes, and couscous. It is also fermentedto make beer and alcohol. Wheat can also be used as a biofuel. Asecondary value to wheat is as a forage crop for livestock.The broad dependence on wheat crops as a primary foodsource accounts for its price strength in the futures market. Anynegative outcome in conditions, including freezes, droughts, andexceptionally short growing seasons, affects supplies worldwide. Asa consequence, prices rise. With this in mind, it is doubtful thatwheat prices are likely to decline on a permanent basis in the future.The science of wheat breeding and expansion is complex. Objectives include high yield, resistance to disease and insects, andweather tolerance. Major species include common wheat, alsocalled bread wheat. This is the most commonly grown form ofwheat in the world. Other varieties include durum, einkorn,emmer, and spelt. In the commodities market, wheat grain is classified by properties to determine price levels. In 2007, futures pricesspiked in the wheat market due to freezes and floods in the northern hemisphere and a serious drought in Australia.The demand for wheat is strong worldwide. Global consumption averaged 101 kilograms per person in 1997.1 Wheat consumption in China is one-sixth of the total worldwide consumption, and,whereas rice grows only in limited climates, wheat grows in manyregions, making it a more reliable food staple. Most varieties ofwheat require 110 to 130 days from planting to harvest, varying byclimate, soil conditions, and type.According to the United Nations Food and Agriculture Organization (www.fao.org) wheat shortages are not uncommon, especially in third world countries, where wheat production is highestand dependence on wheat is greatest. Wheat production as of 2005(measured in millions of metric tons) was:CountryChinaIndiaUnited StatesRussiaFranceCanadaAustralia
Production96725746372624
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GermanyPakistanTurkeyOther nationsWorld Total
242221201626
In the United States, several subclasses of wheat are popular.These include durum, hard red spring, hard red winter, soft redwinter, hard white, and soft white. Each of these varieties is usedin specific food and other end uses.Figure 10-2 shows the December 2007 chart for March 2008wheat contracts.
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RiceAfter corn and wheat, the third most important crop worldwide isrice. Although these other crops are more widely used, many parts
F I G U R E 1 0 . 2 . W H E AT — M A R C H C O N T R A C T
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of Asia depend on rice as a major food source. These regions arecharacterized by high rainfalls and a plentiful supply of water. As acrop, rice provides 20% of worldwide calorie intake.Rice growth requires planting of seeds, followed by flooding ofthe field. Proper planning and soil conservation requires carefuldrainage and channeling as well as careful control of hearty weeds,insect pests, and disease, especially in the submerged field areas.Rice can be grown without the flooding approach, but these otherapproaches demand higher levels of weed and pest control ingrowth seasons as well as a more complex fertilization method.In addition to the well-known use of rice as a daily food, rawrice is also ground into flour and then used for production of ricemilk and sake (rice wine), as well as many varieties of noodles.However, even though it is used as a primary food in many regions,rice is not a complete protein, meaning it does not contain a fullrange of essential amino acids. Rice can be puffed (or popped) byheating the pellets and then used as a source for cereal grains andother foods.Rice has been grown in the United States since the seventeenthcentury, when it was introduced in the Carolinas. The southernstates grew large volumes of rice during the seventeenth and eighteenth centuries, with production accelerated after invention of therice mill and the use of water power. With the end of slavery afterthe Civil War, rice production was less profitable. At the time of theCalifornia Gold Rush of 1849, rice cultivation became widespread,with the use of Chinese immigrant labor. By 2006, the upper SanJoaquin Valley (six counties north of Sacramento) was the secondmost productive rice growing area in the United States, after Arkansas.Production worldwide of paddy rice crop, as reported by theUnited Nations Food and Agriculture Organization, measured inmillions of metric tons, was:CountryChinaIndiaIndonesiaBangladesh
Production1821375440
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VietnamThailandMyanmarPakistanPhilippinesBrazilJapanOther nationsWorld Total
36272518151311142700
This growth level reflects a strong rise in worldwide productionsince 1960, when production was only 200 million metric tons peryear. Exports are relatively small, however, with only about 5% ofall rice sent to other countries. The three largest rice exporters areThailand (26% of exports), Vietnam (15%), and the United States(11%). The three largest importers of rice are Indonesia (14%),Bangladesh (4%), and Brazil (3%). Most paddy rice is used domestically, especially in Asia. In Cambodia, for example, 90% of thetotal agricultural land area is used for rice production.These realities indicate continuing strong markets for riceworldwide. Because it is a primary food in so many heavily populated regions (notably those with growing population levels), ricewill continue to report strong price support into the future.Figure 10-3 summarizes the December 2007 chart for theMarch 2008 rice contract.Note the October through December strong rise in price levels,accompanied with the Relative Strength Index (RSI) remainingbelow 80. This indicates that the price level remained reasonableand had not moved into ‘‘overbought’’ areas.
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CottonFew commodities have had as much effect on U.S. economic history than cotton. In the nineteenth century, the expression ‘‘Cottonis king’’ had great significance, and the differences between theindustrial north and the agricultural south had much to do with theroots of the Civil War. Before gold was discovered in California in1849, cotton was the chief consumer product not only domesticallybut also as an export.
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FIGURE 10.3. RICE—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
It all happened in only a few decades. In 1800, the UnitedStates did not produce cotton. By 1860, the south was exportingfive-sixths of the world’s cotton, over 2 billion pounds every year.One author observed that this industry ‘‘was then about as important as the oil industry in the Middle East today . . .’’2 The CivilWar, the causes of which were varied and complex, caused a sudden upward spike in cotton prices, and speculators ran prices upward and downward for many years to come.By 2007, the three leading cotton-producing countries wereChina, India, and the United States. Leading exporters of cottonwere the United States, Uzbekistan, and India. In the UnitedStates, Texas led in overall production, but California had the highest yield per acre of cotton crop. Because cotton requires an abundance of sunshine, long periods without frost, and adequate
Agriculture
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rainfall, seasonally dry areas are most productive for cotton harvesting.Genetically modified (GM) cotton is used worldwide as a substitute that overcomes pesticide use for naturally grown crops. In2002, 20% of the world’s cotton was GM; by 2003, GM cotton was73%. One of the greatest rates of growth in GM cotton occurred inIndia. In 2002, India yielded 50,000 hectares of cotton, but by2006 India was producing 3.8 million hectares, or 76 times morethan only four years before. Today, India has more GM cotton thanany other country, including China.Looking back, eighteenth century innovations in Great Britainenabled the industrial revolution to go into high gear. Among themost important inventions were the spinning jenny, the spinningframe, and the flyer-and-bobbin system for drawing cotton to auniform thickness. In the United States, Eli Whitney’s cotton ginmade production even easier and faster. However, these inventionsalso led to a decline in cotton labor, as manual harvesting was replaced by machinery. Today, cotton is among the U.S. major exports, notably from the southern state region.Cotton is used primarily in textile manufacturing; most peoplealso recognize the cotton fibers in clothing as a primary elementin blends. Cotton also is used to manufacture denim, corduroy,seersucker, terrycloth, and twill. Most socks, underwear, and Tshirts are also cotton, as well as a majority of bedding products.Beyond clothing, cotton is also used widely to knit and crochetand blended with rayon and polyester. Other industries rely on cotton as well, and it is used to manufacture fish netting, coffee filters,gunpowder, paper, and tents. Cottonseed is used to produce cottonseed oil. Shiny cotton, a processed variety, is used to manufacture clothing resembling satin, and is used in shirts as well as suits.In Asia, cotton is used to manufacture mattresses, common to thatregion.U.S. production of cotton is not on par with other countries,and 25,000 cotton growers in the United States are subsidized,with the government paying approximately $2 billion per year. Achange in these subsidies could affect domestic cotton prices, aswell as continued trends in other countries to dominate the produc-
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Classifications of Futures
tion and export of cotton. Given the potential for less viable markets in the future (for example, if the subsidies were stopped), thefutures market for cotton is not as strong as that for commoditiesused as food and manufacturing products and in continuing andgrowing demand.Figure 10-4 summarizes the December 2007 chart for March2008 cotton.Note the roller coaster of price ranges in the last few months of2007. However, with the variance of eight points, both MACD andRSI indicated that the price range was within reason, based onthose technical standards. This points out the value of supplementing price information with technical tests, also indicating thatcotton’s futures price trends can offer short-term speculative opportunities.FIGURE 10.4. COTTON—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
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OatsThe most significant cereal grain is the oat grain. However, it isequally important as a source of livestock feed, for both horses andother cattle. Oats are also used in production of dog food and arewidely used as chicken feed. As such, oats futures prices also directly affect livestock futures.Oats grow in most temperate zones and do well with relativelylow summer heat compared to other grains. Oats also are moretolerant of high rainfall compared with wheat, rye, and barley. Socooler, wet summers in countries of northwest Europe (includingGreat Britain and even Iceland) do not prevent successful oatcrops.Oat bread was first introduced in England, and today oats areused as a main ingredient in Scottish diets. In fact, the famouslexicographer Samuel Johnson defined oats as ‘‘a grain, which inEngland is generally given to horses, but in Scotland supports thepeople.’’3According to the UN Food and Agriculture Organization,worldwide production as of 2005 (in millions of metric tons) was:CountryRussiaCanadaUnited StatesPolandFinlandAustraliaGermanyBelarusChinaUkraineOther nationsWorld Total
Production5.13.31.71.31.21.11.00.80.80.87.524.6
Oats are used in many types of food. Rolled or crushed, theybecome oatmeal or can be ground into oat flour. Products includeporridge, oatcakes, cookies, muesli, and granola. In Great Britain,a variety of beer called oatmeal stout includes oats for the wort. In
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Scotland, the husks of oats are soaked and the remaining flourymeal strained off and boiled to make a dish called sowans.Dehulled and rolled oats are used as feed for horses, and wholeor ground oats are also used as cattle feed. Oat straw is also usedin skin conditioners and lotions. Figure 10-5 shows a chart for theMarch 2008 contract as of December 2007.
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SoybeansThree distinct futures contracts trade on this product: soybeans,soy meal, and soy oil. Each has its own distinct uses and applications.Most soy crop is extracted for conversion to oil, and soy mealis primarily used for livestock feed. A relatively small amount of soycrop is used directly as food for humans, but this varies regionally
FIGURE 10.5. OATS—MARCH CONTRACT
Source: Charts provided courtesy of TradingCharts.com: http//futures.tradingcharts.com; created with SuperCharts by Omega Research 䉷 1997.
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with most consumption occurring in Asian regions (for example,soy sauce, tempeh, and miso). Soy is also used in a number ofprocessed foods. In the United States, soy was first used in thelate eighteenth century, grown for hay as livestock feed. However,outside of Asia, soy did not become used widely until early in thetwentieth century.Soybeans grow best in climates with hot summers. When meantemperatures fall under 68 degrees Fahrenheit, growth of so