Noticed the Oil Backup?

By Brad Zigler

Oil prices were turned upside down this week when the premium normally enjoyed by the U.S. crude benchmark gave way to a discount to its European counterpart. West Texas Intermediate, the basis grade for the New York Mercantile Exchange's (NYMEX) light, sweet crude contract, historically trades $1.45 per barrel higher than the heavier and more sour Brent grade tracked by the Intercontinental Exchange (ICE) futures.

The average daily WTI premium shrank to 74 cents a barrel last week. Then, this week, the U.S. benchmark slipped to an average 31-cent discount to Dated Brent.

WTI Premium/Discount Vs. Quarterly Contango

There's talk in some circles that the discount somehow reflects market participants switching their trading focus from the NYMEX market to ICE in anticipation of increased regulation of the U.S. bourse by the Commodity Futures Trading Commission (ICE is regulated by the U.K.'s more-relaxed Financial Services Authority).

While it's true CFTC Chairman Gary Gensler has called for hearings to solicit the market's appetite for federally mandated position limits, there's a much more immediate economic rationale for the recent WTI discount.

Look at the chart above. Note the WTI premium/discount (in red) is a virtual mirror image of the contango/backwardation (in black) in the WTI delivery calendar. In other words, a discount corresponds with a large contango; a premium spike accompanies backwardation. (Confused by "contango" and "backwardation"? See "Contango's Cost To Oil ETF Investors.")

A contango - that is, a back-month premium - expands when there's excess supply available. Backwardation denotes tightness. Keep in mind that we're talking about supply deliverable through the terminus at Cushing, Okla., not necessarily the entire U.S. oil market.

Over the past four weeks, inventories at Cushing have climbed 7.8% to 30.8 million barrels even though overall U.S. stocks have dipped 2.2%.

Over that same four-week period, the profit that could be earned from carrying forward-contracted oil for three months jumped from 11 cents per barrel (0.6% per annum) to $2.37 per barrel (14.5% per annum). Put simply, there's money to be made in the oil carry trade again.

You may recall that oil company trading desks took down big profits with such tactics last winter as crude prices plummeted.

When North Sea crude is cheaper than WTI - the historic norm - spot cargoes priced off Dated Brent tend to move to the U.S. Gulf of Mexico rather than to European portals. Bottlenecks, due to either to infrastructure limitations at Cushing or to hoarding to earn carry, flips WTI into discount, discouraging the import of Brent grades. The discount, in fact, suggests that oil should be exported out of the U.S. to Europe.

We'll need to wait and see when, and if, that happens.

*Note: To provide a longer-term perspective, we've pushed back the base for our real-time monetary inflation indicator to May 2006. The base previously was January 2008. The indicator represents the average annual rate of monetary inflation over the period. The current 12-month inflation rate is -3.2%.

Comments

[Brad Johnson:]

Your facts are wrong.

The bill was actually signed into law by President Bill Clinton in 2000.

en.wikipedia.org/wiki/...

Shouldn't the President that signed this legislation into law be held more responsible than one Senator?


On Jul 25 09:29 AM The Greatest Rip Off of our Time wrote:

> There is no oil shortage, just the ultra rich playing in the oil
> commodities market and pushing the price up and taking gas and diesel
> along for the ride. This is also finishing off whatever chance America
> had for a rebound from the coming Second Great Depression. It is
> not about supply and demand anymore, rather it is control of supply.
>
>
> We can all blame Phil Graham with the Commodity Futures Modernization
> Act passed in 2001. That 262-page bill led to the Enron mess, the
> sub-prime lending disaster, and opened the door to the “Dark Energy”
> speculation trading.
> For some good reading on this subject check out this site.
> Global Research.
> www.globalresearch.ca/...;aid=8878<br/>
>
> Also read more about it at this site:
> losangeles.injuryboard...

Jul 25 06:59 PM

[merv.:]

Please don't jump on me for asking a simple question. What is contango? Thank you.

Jul 25 07:59 PM

[buyforeclos...:]

You say forget the US? The world largest economy? Hell, California is the worlds 8th largest economy.If JUST Californians drove 30% less, the World Oil markets would feel it. l DO agree in time Oil will be heading higher as it is a finite commod and will eventually run out in its natural state, although I have heard that Oil can me manufactured from numerous things although I really have not researched it . Also , as more and more Chinese, Indians, Brazillians, Southeast Asians.....start driving cars and get off the motor bikes...but that is many years away. Most Chinese are actually very low wage earners as are Indians. What one has to respect, and not diminish, is the U.S role in inflating Oil prices to begin with,, If we hadn't been such oil gluttons the last 12 years Oil would probably have never reached $100 a barrel. In fact $69 would seem outrageous. It was 11 bucks a barrel as early as 1998! Think about that. Now that unemployment in California is heading to 13%-14% and the US to 11% +, not to mentions Europe and most parts of the world. With more people paying off debt and increasing saving, spending less, and driving a LOT less, you have to ask yourself a simple question. Will the demand for oil go lower or higher? If the US and Europe among other countries are hording cash and losing more and more jobs, and with no end to the housing crisis is sight ( forget what you hear on CNBC, Cramer, papers...all that. I am a Realtor in LA and I can tell you I will still be selling foreclosures in 5 years..been there and done that in the 90's and this times its worse ) you can bet demand is going much lower as the largest user in the world just isn't buyng nearly as much for the foreseeable future. That being said, Goldman Sachs and others are hell bent on getting Oil to high 70's low 80's and MAY succeed due to a Manipulated Bull stock market. Oil is clearly trading with the market , a weaker dollar, but NOT on demand. I have never seen a market manipulated like this one. I am CERTAIN GS and others like Piper Jaffry, UBS and most, if not all analyst, created false earnings that were way TOO to pump the Dow to 14000 and went SHORT when the market got to peak. Then they came out with the doom and gloom last year sending the Dow to 6500 and fleecing hard working Americans and international investors out of their money... If that wasn't bad enough, A lot of Americans and others took money out of the market near bottom and then They did it again! This time they went long at 6500 and they all had ridiculously LOW earnings estimates and they KNEW most would beat.And they are still at it. So now they are making a fortune on the bull market Rally buying all these blue chip stocks and UPGRADING heavily shorted stocks they buy for a trade... I know they are doing this but sure wish I could prove it. Many of these scumbags would go to prison if the SEC didnt have their head up their asses for the last 5 years. I also know that the Dow will probably be squeezed to 10,000 + - and S and P 1,200 + - before the next sell off begins. Goldman and others will go short at that time and then start downgrading stocks based on valuation and poor growth prospects, higher unemployment and other various factors, none the least the impending Commercial real estate bust and use that as their rationale for their flip flop back into the Bears den.....If this plays out as I suspect, Oil will go to the 40's minimum and as crazy as this sounds, could test new lows if the dollar becomes a safe haven again ....laugh all you want as I know the amount of $ printing going on but it could if the commercial crisis is as bad as I think its going to be. That and other nations will have to print more also.



Another world wide stimulus is all but certain

Jul 25 08:37 PM

[buyforeclos...:]

ps - The other thing everbody seems to be ignoring is consumer spending is 2/3 GDP. So given the fact the majority of Americans disposable income is way down, how is it that with higher gas prices we are going to be able to have more money to spend? How is that going to benefit anybody or any corporation? Also it seems to me China's exports have fallen off a cliff and their DOMESTIC stimulus will only temporarily benefit copper and other commodities...and that China is really just stockpiling at very cheap prices. What happens when they decide they have enough? I think they already have. I think China's stimulus was just a way to buy TIME and hope the US and others recover as to increase their exports. But if that doesn't happen, and I feel I made a case that it won't, then what? Where do crude prices go then? Invariably down I would suspect.

Jul 25 08:54 PM

[Brad Zigler:]

Contango exists when an immediately deliverable commodity is priced lower than a deferred delivery e.g., when September crude oil trades under December futures.



On Jul 25 07:59 PM merv. wrote:

> Please don't jump on me for asking a simple question. What is contango?
> Thank you.

Jul 25 10:21 PM

[Ron2008:]

Your facts are wrong.

The bill was actually signed into law by President Bill Clinton in 2000.

en.wikipedia.org/wiki/...

Shouldn't the President that signed this legislation into law be held more responsible than one Senator?
==============

Uh no?

Funny how Republicans want to blame Clinton for signing a Republican sponsered bill that was passed with a veto proof majority.

Jul 25 10:59 PM

[sethmcs:]

I remember in the 70s how we were going to run out of oil. Nonsense. I see oil droping to the 30s as soon as England, France and the USA limit the amount of oil contracts speculators can hold. As a matter of fact, any "bank" that received TARP should be forbidden from trading commodities period. The risk is too high. Further, regulation should make it impossible for any individual firm to control enough oil contracts to move the price significantly unless they take physical delivery. Currently, the amount of money needed to manipulate the market is too low. Failure to make these reforms will result in a second oil shock that will push the world economy back into a deeper recession.

Jul 26 12:48 AM

[China Yankee:]

buyforeclose ----

I am sure you are a great realtor and under stand what is happening in California but you are OFF a bit when it comes to China .

I am an expat working in China and I can tell you that right now the cars on the streets are exploding .China is now selling more cars then the USA .They have lowered taxes on new cars and made loans available to most of the people .GM and Ford are making good profits in China .

The cars on the road in India are also increasing dramaticly , not to mention Vietnam - Indonesia -Brazil . The price of oil MAY go down to the high 50,s because of the surplus now but will be higher by the end of the year .

Jul 26 12:54 AM

[The Greates...:]

When Congress passed the Commodity Exchange Act in 1936, they did so with the understanding that speculators should not be allowed to dominate the commodities futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain speculators virtually unlimited access to the commodities futures markets. The CFTC has granted Wall Street banks [like Goldman Sachs] an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. This has effectively opened a loophole for unlimited speculation. When Index Speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits.
The really shocking thing about the Swaps Loophole is that Speculators of all stripes can use it to access the futures markets. So if a hedge fund wants a $500 million position in Wheat, which is way beyond position limits, they can enter into swap with a Wall Street bank and then the bank buys $500 million worth of Wheat futures.
In the CFTC’s classification scheme all Speculators accessing the futures markets through the Swaps Loophole are categorized as “Commercial” rather than “Non-Commercial.” The result is a gross distortion in data that effectively hides the full impact of Index Speculation.

Jul 26 11:10 AM

[Brad Zigler:]

So, would you say that this explains the oft-reviled short positions in precious metal futures held by U.S. banks?

Are these banks merely hedging the swap exposures granted to fund customers rather than colluding with the central bank in a scheme to manipulate the price of metals lower?


On Jul 26 11:10 AM The Greatest Rip Off of our Time wrote:

> When Congress passed the Commodity Exchange Act in 1936, they did
> so with the understanding that speculators should not be allowed
> to dominate the commodities futures markets. Unfortunately, the CFTC
> has taken deliberate steps to allow certain speculators virtually
> unlimited access to the commodities futures markets. The CFTC has
> granted Wall Street banks [like Goldman Sachs] an exemption from
> speculative position limits when these banks hedge over-the-counter
> swaps transactions. This has effectively opened a loophole for unlimited
> speculation. When Index Speculators enter into commodity index swaps,
> which 85-90% of them do, they face no speculative position limits.
>
> The really shocking thing about the Swaps Loophole is that Speculators
> of all stripes can use it to access the futures markets. So if a
> hedge fund wants a $500 million position in Wheat, which is way beyond
> position limits, they can enter into swap with a Wall Street bank
> and then the bank buys $500 million worth of Wheat futures.
> In the CFTC’s classification scheme all Speculators accessing the
> futures markets through the Swaps Loophole are categorized as “Commercial”
> rather than “Non-Commercial.” The result is a gross distortion in
> data that effectively hides the full impact of Index Speculation.

Jul 26 11:40 AM

[Brad Zigler:]

Though, by the strictest definition, contango actually represents the premium OVER the cost of carry (storage, insurance and financing costs).


On Jul 25 10:21 PM Brad Zigler wrote:

> Contango exists when an immediately deliverable commodity is priced
> lower than a deferred delivery e.g., when September crude oil trades
> under December futures.
>

Jul 26 11:44 AM

[nobby73:]

The central banks are the OTC swaps counterparties for the precious metals shorts....


On Jul 26 11:40 AM Brad Zigler wrote:

> So, would you say that this explains the oft-reviled short positions
> in precious metal futures held by U.S. banks?
>
> Are these banks merely hedging the swap exposures granted to fund
> customers rather than colluding with the central bank in a scheme
> to manipulate the price of metals lower?

Jul 26 12:34 PM

[Brad Zigler:]

WHERE did you get the notion that a central bank would contract for long metal exposure with a swaps dealing bank?

Got some proof?


On Jul 26 12:34 PM nobby73 wrote:

> The central banks are the OTC swaps counterparties for the precious
> metals shorts....

Jul 26 02:24 PM

[nobby73:]

They aren't going long, they are selling via swaps, which enables the banks to short futures as hedges..


On Jul 26 02:24 PM Brad Zigler wrote:

> WHERE did you get the notion that a central bank would contract for
> long metal exposure with a swaps dealing bank?
>
> Got some proof?

Jul 26 04:37 PM

[Alfredo Mar...:]

The bill was actually co-sponsored by several Democrat Senators, including Senator Harkin (D-IA) and Senator Johnson (D-SD).

It's a ridiculous theory being peddled around by liberals that Senator Graham somehow brought down the entire economy a decade later. Who knew this one Senator had so much power?

They conveniently leave out that this legislation had bipartisan support, and it was signed into law by a Democrat President, so if you want to blame anyone, blame Bill Clinton.


On Jul 25 10:59 PM Ron2008 wrote:

> Your facts are wrong.
>
> The bill was actually signed into law by President Bill Clinton in
> 2000.
>
> en.wikipedia.org/wiki/...
>
> Shouldn't the President that signed this legislation into law be
> held more responsible than one Senator?
> ==============
>
> Uh no?
>
> Funny how Republicans want to blame Clinton for signing a Republican
> sponsered bill that was passed with a veto proof majority.

Jul 26 08:27 PM

[LOLcapitali...:]

This is a little off the subject, so I apologize in advance and give fair warning to stop reading if you like.

China has also made credit available as part of their stimulus package equal to approximately 1/3 of GDP. That's like the US forcing $4.5 trillion through the banking system into loans with virtually no credit quality. Chinese money supply expanded 28.5% in June 2009 (yes, in one month) alone. No credible person (who is aware of the situation) thinks there won't be severe consequences resulting from the debt bubble currently being created in China's already near-insolvent banking system. Combine that with an untenable internal geopolitical position and it seems to me that there's more downside in China than upside.

The funny thing is everything looks like it's going amazingly well (people buying cars, building office buildings, etc.) right up until they hit the wall. We have only to look at the US housing bubble to see a less severe example of the bursting of a massive asset bubble funded by debt.

Sorry, I know I'm a tiny minority here, but I'm not an optimist on China.


On Jul 26 12:54 AM China Yankee wrote:

> buyforeclose ----
>
> I am sure you are a great realtor and under stand what is happening
> in California but you are OFF a bit when it comes to China .
>
> I am an expat working in China and I can tell you that right now
> the cars on the streets are exploding .China is now selling more
> cars then the USA .They have lowered taxes on new cars and made loans
> available to most of the people .GM and Ford are making good profits
> in China .
>
> The cars on the road in India are also increasing dramaticly , not
> to mention Vietnam - Indonesia -Brazil . The price of oil MAY go
> down to the high 50,s because of the surplus now but will be higher
> by the end of the year .

Jul 27 02:53 PM

[bricki:]

The bill passed with more than a 2/3 majority. Sign it or not it's still law.

The big problem with the bill is the so-called "Enron Loophole" which exempted most OTC and electronic trades. This loophole lies squarely at the feet of Phil Graham who put it in the bill after much lobbying by Enron.

Democrats tried to change this loophole several times in 2000-2008 including in the so-called Feinstein amendment in 2003 up through June 2008 when they were finally able to override a veto by President Bush.

Like it or not the main harm caused by this bill was due to actions by Republicans who both wrote the crippling clause but also blocked efforts to remove this clause.

The fact is that if you look at the legislative history of Phil Graham there is a lot of reason to believe that the deregulative measures he sponsored had much to do with this recession.

On Jul 26 08:27 PM Alfredo Martinez wrote:

> The bill was actually co-sponsored by several Democrat Senators,
> including Senator Harkin (D-IA) and Senator Johnson (D-SD).
>
> It's a ridiculous theory being peddled around by liberals that Senator
> Graham somehow brought down the entire economy a decade later. Who
> knew this one Senator had so much power?
>
> They conveniently leave out that this legislation had bipartisan
> support, and it was signed into law by a Democrat President, so if
> you want to blame anyone, blame Bill Clinton.

Jul 27 05:00 PM

[buyforeclos...:]

Maybe your right..but has it occurred to you that the only reason there have been a lot of car sales is ONLY because A.) Tax benefits B.) bank loans to every body and their mother for homes and just about anything... and a lot of those loans have gone into the stock market because you should know how emotional the Chinese are when it comes to MONEY... hell they probably maxed theior credit card advances to get in on a near 100% rally

For every action there is a reaction... but eventually the piper has to be paid


On Jul 26 12:54 AM China Yankee wrote:

> buyforeclose ----
>
> I am sure you are a great realtor and under stand what is happening
> in California but you are OFF a bit when it comes to China .
>
> I am an expat working in China and I can tell you that right now
> the cars on the streets are exploding .China is now selling more
> cars then the USA .They have lowered taxes on new cars and made loans
> available to most of the people .GM and Ford are making good profits
> in China .
>
> The cars on the road in India are also increasing dramaticly , not
> to mention Vietnam - Indonesia -Brazil . The price of oil MAY go
> down to the high 50,s because of the surplus now but will be higher
> by the end of the year .

Jul 27 07:22 PM

[Hot Richard:]

Doesn't the largest, most powerful, wealthiest, and successful cartel in history largely control price, production, and supply of oil?

I've seen too many indicators of oil demand rising steady for the next 40 years.

Jul 27 10:33 PM

[Brad Johnson:]

Most of the deregulation of the banking and energy industry that liberals howl about was signed into law by Democrat President Bill Clinton.

Regardless of the vote total, scores of Democrats voted for these bills, and a Democrat President signed them into law. To blame this on one Senator is ridiculous.

This absurd notion that the Democrats "didn't want this one really bad part of the bill, but those rascally Republicans made them sign on" is absurd. If they didn't like the bill they shouldn't have voted for it or signed it into law. They share the blame equally.


On Jul 27 05:00 PM bricki wrote:

> The bill passed with more than a 2/3 majority. Sign it or not it's
> still law.
>
> The big problem with the bill is the so-called "Enron Loophole" which
> exempted most OTC and electronic trades. This loophole lies squarely
> at the feet of Phil Graham who put it in the bill after much lobbying
> by Enron.
>
> Democrats tried to change this loophole several times in 2000-2008
> including in the so-called Feinstein amendment in 2003 up through
> June 2008 when they were finally able to override a veto by President
> Bush.
>
> Like it or not the main harm caused by this bill was due to actions
> by Republicans who both wrote the crippling clause but also blocked
> efforts to remove this clause.
>
> The fact is that if you look at the legislative history of Phil Graham
> there is a lot of reason to believe that the deregulative measures
> he sponsored had much to do with this recession.
>
> On Jul 26 08:27 PM Alfredo Martinez wrote:

Jul 28 03:59 PM