The contango between the front-month April contract and the second-month May contract has been severely smashed over the last day.
Having averaged a difference of about $2 per barrel over the last couple of weeks, the two contracts are now trading at an interval of around $1 — April at some $47.54 per barrel and May at $48.52 per barrel.
The big question now is does this mark the sign of a renewed rally or is it simply a good opportunity to short oil?
As to the case for a potential renewed bull-trend: Opec meets on March 15th and is now largely expected to keep current production targets unchanged – an indication the cartel perhaps feels enough production has now been taken out to support prices. Instead, Saudi Arabia is calling for stricter compliance with existing quotas. Although analysts do say compliance to quotas has been unusually high – averaging some 80 per cent.
A good indicator of just how much activity as has been ‘layed to rest’ so to speak, was last week’s international rig count from Baker Hughes. The index, a signal for industry expectations of future demand, showed the number of oil and natural gas rigs operating around the world falling by 7.4 per cent in February — that’s the lowest level since April 2006.
The vast majority of that decline was in the US, where the rig counts fell 233, or 15 per cent, to 1,320. In the Middle East, meanwhile, rig counts fell by 3.7 per cent, in February to 274.
As can be seen in the chart below, the figures mark a clear beyond-seasonal reduction – a reflection of just how much demand expectations have had to be cut back.
On the products side, meanwhile, there is also renewed hope of a pickup in gasoline consumption and the end of so-called ”demand destruction’ in the US. Retail gasoline prices rose for the eighth time this year according to the latest weekly EIA data — although that is in line with the normal seasonal rebound. In contrast, however, diesel prices are falling, reflecting an overall weakness in middle distillates. Refineries too appear relatively unwilling to increase runs at any large scale, even though traditionally they would be doing so at this time of year.
Of course, while the global supply and demand picture may have rebalanced, the chances of any steep recovery in prices is still very slim. For one, the return of ‘spare capacity’ to the industry should prevent any major spikes developing in the near term. Secondly, future demand out of China is still a big unknown – and anything can change here.
Also worth noting is the relative price of the WTI to the natural gas benchmark Henry Hub price. As pointed out by Stephen Schork of the Schork report the Hub/WTI ratio is now at a five-month high. As he explains (our emphasis):
Spot crude oil futures on the NYMEX might be headed to $50, but Henry Hub gas futures appear to be on the way to zero or, at the very least, $2.999. Yesterday, while April WTI soared, April gas plunged to a life-of-contract low, 3.809. As a result, the Cushing/Henry Hub ratio surged to a five-month high, 1.218. In other words, WTI is dear and/or natural gas is cheap. If you ask us, we’ll venture it is more of a case of the former, rather than the latter.
He goes on to point out that while the WTI’s strong price path on Monday was certainly strong, its rise somewhat oddly came despite a marked weakness in the rest of the energy complex on both sides of the Atlantic, which could suggest some WTI-specific contract irregularities.
Another good point, as made by Dennis Gartman of the Gartman report, are what the actual implications of the contango-trade unwind will be. As he explains:
Those who bought crude in the front, took delivery, had the crude stored in ships or tanks or rail cars et al, and who sold the back months to hedge in the huge carrying charges that were on offer two and three months ago are now sitting upon huge profits. Indeed, the only thing that shall keep crude oil prices from moving rather sharply higher shall be the reemergence of this stored crude oil back to the market as the shifting term structure demands that that crude put into storage be drawn out.
Effectively, just how will the market respond to increasing amounts of stored oil being released to the market?
Related links:
WTI back on top – FT Alphaville
WTI-Brent spread narrows – FT Alphaville
WTI curve – Nymex