This page has been archived and commenting is disabled.
What Does A Flattening Oil Contango Mean?
By Dian L. Chu, Economic Forecasts & Opinions
Starting about ten months ago, if you have access to oil storage tanks plus enough financial resources, sky was the limit to buying spot crude oil and selling a year or so forward on Nymex. For more than six months, it was a highly profitable trade when the spread between the near-month and forward contracts was about $10/bbl or more with a return of more than 15% (Fig. 1). During the super contago phase of late 2008 and early 2009, the spread was so ridiculously wide that the rate of return was close to 70% at one point of time.
Why is the Contango Flattening?
You may recall that the spread gap opened just a few weeks after Lehman Brothers failed and AIG required a capital infusion. Those few who had a role in taking advantage of the super contango ended up boosting the spot oil price back to a more normal relationship to the outer months. This is one of the reasons that the contango in the WTI Nymex crude market has weakened over the last few months quite substantially (Fig. 2).
In addition, the weakening contango in Nymex might also be related to an investigation by the Commodities Futures Trading Commission (CFTC) and other authorities into long-only funds and ETFs. Since much of the long-only fund buying has taken place in the futures, their liquidation in response to the regulatory investigation is likely putting downward pressure on futures contracts, narrowing the contango in WTI Nymex.
Reviewing Market Fundamentals
Spot prices becoming more expensive relative to future prices will typically encourage refiners to convert crude into product drawing down crude inventory. It will also dis-incentivize speculative crude storage hoarding, and provides incentives for producers, and OPEC in particular, to start some of the shelved projects. The same goes for non-OPEC producers. So a weakening contango, if sustained, will likely help normalize the crude supply and inventory levels.
However, the demand outlook remains dismal. The U.S. EIA just reported domestic consumption of liquid fuels and other petroleum products declined by almost 6.3% year-over-year during the first half of the year, one of the steepest declines on record. Total consumption is now projected to decrease by about 4% year-over-year in 2009 and grow only 1.4% in 2010 (Fig. 3). The latest EIA weekly petroleum report also showed the year on year U.S. gasoline inventory was 23.1% higher, while distillate fuels rose to their highest level since January 1983 (Fig. 4).
Is it Bullish?
A narrowing contango is traditionally seen as a bullish sign for the crude market, but investors interpreting the current flattening contango as such should probably beware. Based purely on market fundamentals, crude oil should be priced around $40 a barrel. At the moment, the murky economic and demand outlook is not yet supportive of the current oil price levels. The risk is likely on the down side in the near term, as any further increases in crude prices are less likely without an increase in consumption.
Goldilocks of Oil Prices
Nonetheless, once economic recovery returns, demand may jump sharply and then the existing oil reserves would come under pressure. In addition, crude prices of late have been tied to the equity markets, which have been trading irrationally on a weak dollar rally. Amid expectations of a further weakening U.S. dollar against emerging markets currencies, coupled with the current seemingly satisfactory oil price levels to both consumers and producers, crude price could well be sustained at around $60 to $75 a barrel range quite possibly through 2011 or 2012 barring any Force Majeure events.
Dian L. Chu, Economic Forecasts & Opinions
##I Say Let's Evolve. ##
»
- advertisements -
I appreciate your work, the post is really helpful. I found so many interesting stuff in your blog especially its discussion. It's some pretty great info, I appreciate the information you provided is excellent post.
http://theworldcurrentaffairs.blogspot.com
Thank you for sharing! Now I have a clear idea about what does it mean. free advertising |job|memory foam mattress
USD bull here...
-vreporter
" Is anyone out there bullish on the $USD?"
YES !
My USD long term indicator went bullish a while ago.
MARKET TRENDS :
www.zerohedge.com/forum/market-outlook
I was writing about that just on Tuesday:
http://ftalphaville.ft.com/blog/2009/09/22/73176/boiling-oil-into-backwa...
Is anyone out there bullish on the $USD? The silence is encouraging. With 3% dollars bulls or is that 97% bearish, call me a bull. Maybe oil will get to $40 before it soars to $300.
I would love anyone to comment on the recent spike in Natural Gas prices. I expected NG to follow Crude on the way down, but instead it rallied (today) . Can this be just a short covering rally? My understanding is that Nat Gas storage is almost full...
"Based purely on market fundamentals, crude oil should be priced around $40 a barrel"
How is this figure calculated, all(sensible)responses gratefully accepted, thank you.
Stopped reading right there....shame it was the last para of the article!
good article by asiablues and comments by #77930 and #77937, this post is one of the things that makes ZH very very addictive
Technical analysis for crude oil:
Daily chart - ongoing topping action and now bearish.
Weekly chart - neutral.
Monthly chart - neutral.
MORE:
http://www.zerohedge.com/forum/market-outlook
The enigma is the unkowns.
Be ready for Contango If geopolitical problems heighten.
"Spot prices becoming more expensive relative to future prices ....provides incentives for producers, and OPEC in particular, to start some of the shelved projects."
Just to prove I read this enlightening article, shouldn't it read shelve some recently started projects?
this is a very useful blog for the upcoming businesses .Bespoke software development the points that are listed are grea For any business goal setting and developing a plan are very essential Fabric duct and are the basis for the success.i will be applying these tips in my business .SEO Company
If I read your "enlightened" comment correctly, you have NO idea about the crude oil market. So, allow me to "enlighten" you instead.
if current oil prices are low, oil producers can't fund their capital projects. These projects typically take 4-6 years to even start producing, Why do you think E&P capital budget got cut 40% this year?
The liquidation of funds that only have front month pushes the market away from contango? Maybe I don't understand how selling front month futures pushes the curve to steepen. Now if you want to say the predictability of the roll lets spread players more easily bet on a contango market structure, thus removing it makes it harder, then maybe that is correct. The way you have it phrased now is plain wrong. Once again look at dated brent and you can get a better picture of the spot prices. Also when you look at the benchmark that is world based instead of Cushing OK based, you see less contango meaning fundamentals of the world look better than US. Keep an eye on midcont vs gulf flows for your first sign of a real move.
Well thought out and explained. Great post!
nice post, thank you.
and we heartily agree with your final line.
welcome to the (r)evolution
Big4 slightly net long oil which also flattens the
cotango.
War burns oil even if tapped out consumers do not.
One by one, risk returns disappearing with
accelerating implosion of default driven deflation, covering of shorts and perhaps the return of king
dollar, a discrete view to be sure.
To add to your point re the CFTC, the Madoff Mary Shapiro
SEC put enough pressure on Powershares to make DXO
double long crude disappear, while DTO double short
continues to trade for hedgies who can short it naked
as TG advocated yesterday, which was not widely
reported.
Where we thought you were going was connecting credit
crisis spreads with oil cotango, a very interesting proposition indeed. In that event, cotango could briefly
reappear with a few more debt default surprises as well as the usual Persian Gulf or other chokepoints. Maybe
certain parties have already looked into blowing up
supertankers on holidays...
http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3251493