New NYMEX Futures Price Confidence Intervals

Energy prices are volatile, primarily reflecting market participants' adjustments to new information from physical energy markets and/or energy-related financial derivatives. EIA quantifies this uncertainty, or risk, in the market by using "implied volatilities" derived from the New York Mercantile Exchange (NYMEX) options markets for light, sweet crude oil and natural gas futures prices to construct confidence intervals. Implied volatility is calculated from traded option prices using the Black commodity option pricing model. The confidence intervals reflect the range in which those prices are likely to trade.

A confidence level determines the range of prices within the confidence interval. The confidence level represents the probability that the final market price for a particular futures contract, e.g., December 2009 crude oil, will fall somewhere within the lower and upper limits of the range of prices. For example, if a confidence level of 95 percent is specified, then a range of prices can be estimated within which there is a 95-percent probability the delivered price for the commodity in the contract's delivery month will fall within that range. The higher the specified confidence level, the wider the range between the lower and upper limits.

Confidence intervals tend to be wide, in part because even small imbalances in oil markets can trigger large movements in prices given that both the production and use of oil tend to be relatively insensitive to price changes in the short-run. Increased uncertainty in consumption, production, or many other factors influencing oil prices would tend to induce an increase in implied volatility and a widening of the confidence intervals.

The Current Outlook

Crude Oil. During the 5 days ending October 1, 2009, NYMEX futures market participants were pricing WTI delivered to Cushing, Oklahoma, in December 2009 at an average of $69 per barrel. The 95-percent confidence interval for the December 2009 futures contract is $49 per barrel and $96 per barrel for the lower and upper limits of the confidence interval, respectively; a $47 per barrel range (Figure 1). The low and high confidence limits correspond to a 48-percent implied volatility derived from the NYMEX options market. Confidence intervals also tend to widen as markets look further into the future. For example, the 95-percent lower and upper confidence limits for the December 2010 futures contract are $32 per barrel and $168 per barrel, respectively; a $136 per barrel range.

While near-term implied volatilities are now lower, and confidence intervals narrower, than they were at this time last year, the current confidence intervals highlight the fact that there continues to be significant uncertainty in the outlook for oil prices. EIA's crude oil price forecast reflects all available data and our expert judgment, nonetheless there is a substantial likelihood that prices will diverge significantly from the forecast.

Natural Gas. For the 5 days ending October 1, 2009, natural gas futures on the NYMEX were trading at $5.59 per million Btu (MMBtu) for gas delivered to Henry Hub, Louisiana, during December 2009 (approximately equal to $5.76 per Mcf assuming a natural gas heat content of 1,030 Btu per Mcf). The 95-percent confidence interval around this price has a lower limit of $3.70 and an upper limit of $8.50, a difference of $4.80 per MMBtu, which corresponds to a 56-percent implied volatility (Figure 2).

Last year at this time, NYMEX natural gas to be delivered to Henry Hub in December 2008 was trading at $7.80 per MMBtu. The lower and upper limits of the 95-percent confidence interval were $5.40 and $11.40, respectively. This $6.00-per-MMBtu range corresponded to an implied volatility of 51 percent. The current implied volatility is slightly higher than last year, but because the current natural gas price is more than $2 per MMBtu lower, the price range of the 95-percent confidence interval is smaller.

Forecast Henry Hub natural gas spot prices in this Outlook are about $1 per MMBtu lower than the NYMEX futures prices. While considerable uncertainty in the market persists, this difference reflects EIA's expectation that a significant volume of natural gas production remains economic at prices below the current NYMEX 2010 futures prices. Furthermore, EIA expects that natural gas demand in the electric power sector, which served as a crucial outlet for high natural gas supplies this year, will be limited in 2010 as prices move slightly higher and new coal-fired electric generation capacity becomes available.