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Wall Street isn’t feeling so ‘super’ about the oil trade

China's Largest Crude Oil Tanker Is Built In GuangzhouChina's Largest Crude Oil Tanker Is Built In Guangzhou
China's oil bill is plummeting--but it's passing the savings back to the world in the form of deflation.Photograph by ChinaFotoPress via Getty Images

Some heat has come out of the oil trade.

Back in 2008, the last time oil prices plunged, the oil market predicted a sharp rebound in prices. This time around: Not so much.

The Wall Street term for this is contango. If you were following oil markets in late 2008 and early 2009, you heard a lot about contango. There are spot prices–that’s the $48 a barrel you hear a lot about. And then there are future prices; that’s the price that traders are betting oil will be in six months, a year, or five years from now. And when the future price is higher than the spot price, you have contango.

In general, futures markets tend toward reversion to the mean. When oil prices are high, the futures market expects them to drop, and vice versa. So, contango has been pretty rare in the oil market because oil prices have been relatively high for about two decades. The spot price of a barrel of oil in 1991 was $12. The big exception came in 2008, when oil prices plunged. The oil futures market didn’t just go into contango, it went into what is called “super contango.” In late 2008, the spot price of oil was around $44 a barrel, but the future price at the end of the curve was nearly $80.

At that time, the economy was driving off a cliff into what looked like the worst recession in a long time, a crisis that some said we would never recover from. Things are better now, and getting better, so demand for oil for the next few years should be up. Based on that, and the recent oil price plunge, you would expect that the oil futures market would have gone into super-duper contango.

But it’s hasn’t. Wall Street traders think oil prices will be 35% higher in five years and $65 a barrel by early 2020. That’s about half the jump traders expected back in 2008. “No triple digits as far out as the eye can see,” says Phil Flynn, a trader and oil market analyst at Price Futures Group in Chicago. “Sixty dollars looks like the new normal.”

This could simply mean that traders think low oil prices are here to stay, even for as long as five years. And that could be a really good thing for the U.S. economy. Fracking has boosted the amount of oil out there, but it has also increased the speed at which we can access new reserves of oil. So when global demand rebounds, it will be quickly met with a supply of energy.

But what we are seeing in the futures market could be less about a fundamental change in the oil market and more about a financial one. Back in 2008, banks were pretty active in the commodities markets. One popular thing to do was to take some of their cheap money from customer deposits, or the Federal Reserve, and buy a whole bunch of oil at current prices, put it in tankers offshore, and then hedge it with a futures contract. That locked in huge trading profits for the banks, but it also meant there was a whole bunch of oil sitting around in tankers offshore. This seemed odd to regular people, and less regular politicians, who assumed, probably accurately, that Wall Street’s hoarding was keeping oil and gas prices higher than they should have been. Wall Street calls this hedging. Others call it manipulation.

So, in the past few years, new rules and pressure from politicians and regulators have pushed banks out of the commodities business. Citigroup (C) no longer has a $100 million oil trade. Goldman Sachs (GS) has sold off its metals warehousing unit. And Morgan Stanley (MS) is getting out of the gas business.

There are now fewer banks parking oil offshore. That might feel better. Banks aren’t using consumer deposits to bet that oil prices will rebound, at least not as much. This also might explain why oil prices have plunged 50% at a time when the economy is doing pretty well. The oil market is a lot less super than it used to be.