Prices for prompt delivery of West Texas Intermediate (WTI) crude as quoted on the CME/NYMEX futures exchange fell by 60% from their high over $107/Bbl in June 2014 to a low under $44/Bbl on March 17, 2015. After recovering about 37% in April and May WTI prices have remained stuck close to $60/Bbl ever since - closing yesterday (June 23, 2015) at $61.01/Bbl. With market contango narrowing, inventory levels falling, and refinery throughputs rising – why aren’t prices moving higher faster? Today we review the fundamental data.
For the past year oil market analysts have been busier than shrinks after Thanksgiving – trying to explain what happened and what comes next - since crude prices started falling in June 2014. As we explained last fall the root cause for the price meltdown was a worldwide increase in crude supplies coupled with a downturn in demand (see Crude Falls To Pieces). Crude from U.S. shale based production has been increasing at the rate of 1 MMb/d a year for the past three years - pushing out imports into the world market and creating increased competition between producers to retain their market share and placing downward pressure on prices. When producer group OPEC failed to signal any intent to try and prop up prices at their Thanksgiving meeting the rout gathered pace (see Crying Time At OPEC). With too much crude and too few buyers the market condition known as contango developed where future prices are expected to be higher than spot prices today – encouraging the use of storage to “save” cheap crude today for use when prices recover (see Skipping The Crude Contango). Without new sources of demand or supply interruptions, a contango market keeps downward pressure on today’s market prices as storage fills up and becomes more difficult and expensive to find – increasing the contango spread required to cover storage costs (see Fly Me To The Moon). In March of 2015 we described how sky-high inventory levels were still keeping up the downward pressure on crude prices (see Tank House Blues). More recently we posted a blog at the beginning of June (2015) suggesting that low crude prices were here to stay in a new era of abundance (see Houston We Have A Problem). Other analysts contend that the narrowing contango, falling inventory levels and increased refinery demand seen recently – coupled with a slow down in crude production – are signs that prices should recover further this year. In this two part blog series we look at the impact of evolving fundamental signals on prices.
We start with contango in the CME/NYMEX WTI futures market over the past year. The chart in Figure #1 shows the spreads between WTI prices quoted for delivery six months out (blue line) and one year out (red line) respectively and prices for prompt delivery (light green line). The key to understanding the chart is to look at where the spreads are relative to the light green zero line. If the spreads are above the zero line the market is in contango (meaning future prices are higher than today - orange arrow) and if the spreads are below the zero line the market is in backwardation (future prices are lower than today – black arrow). As you can see the WTI market crossed from backwardation to contango during early November 2014 and the contango spread for 12 months out peaked at about $12/Bbl in March 2015 with the 6 month spread getting as high as $8/Bbl. Since mid-March 2015 the 12-month contango has narrowed to under $3/Bbl and the 6-month contango to under $2/Bbl (see green dashed circle on the chart). Generally speaking a wide contango incentivizes traders to store barrels today in order to retrieve them later at a higher price – as long as the spread covers the cost of storage. As we shall see in a minute the recent narrowing WTI contango spread has made crude storage considerably less profitable – bringing to an end a massive crude inventory build up.