Oil Prices and Jobs

The February employment report from the US Bureau of Labor Statistics came in right about where analysts had been predicting. The US economy added 192,000 jobs and the unemployment rate fell slightly to 8.9%. Job additions in December 2010 and January 2011 were also revised upwards, from 121,000 new jobs in December to 152,000, and from 36,000 in January to 63,000. This is all good news, but rapidly rising prices for crude could put a crimp in job growth by causing consumers and businesses to hold onto more cash to deal with higher energy costs and to spend less on consumption and growth.

Spot prices are above $103/barrel for WTI and $115/barrel for North Sea Brent. The threat to crude supply from Libya and other North African and Middle Eastern producers has created backwardated market in Brent crude, where the price for the near month (April) contract is higher than the price for the far month (March 2012). The following chart from HardAssetsInvestor.com shows both the Brent Crude curve and the roll cost curve:

The market for WTI crude remains in contango, where the front month contract is lower than the far month. Here’s the chart:

The equations for futures are simple: if the spot price is lower than the forward price less the cost of storage, then roll. If the spot price is greater than the forward price less the cost of storage, dump the contract. For Brent, the math works out slightly in favor of rolling the contracts forward. For WTI, the math indicates that selling could be a slightly better option.

In the US, however, there is no shortage of physical WTI crude. The nation’s commercial stocks remain at an all-time high. Between now and mid-March, traders will need to make a decision about whether to take delivery of their April WTI contracts or to roll the contracts forward for another month. If they take delivery, there’s no place to store the crude, so it will go directly to end users like refiners, and very likely at a sharp discount to the headline price of WTI.

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If traders decides to roll the contracts forward, they’ll be following the lead of the United States Oil Fund ETF (NYSE: USO), which must roll its huge number of contracts forward. The flood of roll-overs will push down the prices of both WTI and Brent futures, irrespective of what is happening in Libya and elsewhere.

Falling prices for crude should help bolster the employment outlook in the US, primarily because it leaves consumers with more to spend on goods and employers more to invest in growth. The catch, though, is that if job numbers continue to grow, demand for crude will also grow. That will moderate any fall in crude prices, and depending on the global political climate, could cause another spike in crude prices.

-Paul Ausick