Oil Glut? 1-Year WTI Crude Futures Spread Flips to Contango for the First Time in Over a Year

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Investing Pioneer – 8:40 PM EST – 12/13/2022

On December 9th, for the first time since November 2020, the 1-year WTI (West Texas Intermediate) Crude oil futures spread flipped to contango, meaning there is a price premium for further dated futures contracts (in part an inherent byproduct of making up for storage costs, as the price of the oil + storage cost x storage duration may be inherently built into the price). The opposite of contango is backwardation, which is usually a sign of supply shortages and high demand.

(iPath Pure Beta Crude Oil ETN)

Coupling the fall in WTI price from its June ~$122 peak to the ~$70-80/barrel price level with contango suggests a slight glut in supply at present. At the same time, contango may be thought of as an indicator of bullish sentiment with investors pricing in a potential rise in the price of oil in the future.

This said, analyzing this futures curve data to denote future movements is not necessarily prudent considering the predictive capacity is often minimal.

Brent crude rose to over $80/barrel as the DXY (dollar index – measures the strength of the dollar relative to a basket of other currencies) fell 1%, on slightly slowing inflation (7.1% year-on-year November CPI reading vs 7.3% expectation).

This marks the largest daily gain for oil since November 4th.

Both China’s re-opening and recent price-caps on oil are two major factors in the demand and supply structures of oil at the moment. The Financial Times wrote the European price cap is intended to limit upward pressure on oil prices. Instead of selling at a premium, it would instead be directed to lower and middle-income countries at a discount.

The refilling of the United State’s strategic reserves is another thing the market is waiting for. Amos Hochstein, Energy Security Advisor for the US State Department, says they are considering the two factors outlined in the paragraph above before replenishment.

The extent to which oil demand will fall in a recession is an important consideration. Certain analysts are suggesting drops in demand during a recession are overstated relative to supply conditions impact on price. Meaning, supply side trend analyses may carry more weight going forward. According to Capital.com, ANZ Research data shows oil demand falls between 0-3% on average during a recession (with one -8% outlier).

Generally, considering a continued inflationary environment, one would expect oil prices to remain high. US Federal Reserve interest rate and QT changes will be key drivers for how the market will evolve going forward. The current tightening policy is disinflationary to deflationary (in terms of total credit). If this trend continues, major upwards pressure is a reduced possibility. However, the introduction of a more accommodative policy, which the Fed may eventually perceive as necessary, could further bolster oil demand.

As noted above, China’s re-opening is an important factor in this puzzle. Though initially it may be perceived as bullish for the price of oil, undershooting consensus estimates for economic strength may mean a continued decline.