Contango and Inventory: Clues to Oil's Trend 37 comments
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By now you've probably seen the headline about BP plc's (NYSE: BP) massive new oil discovery in the Gulf of Mexico. Company mouthpieces are talking up the find as even bigger than the 3-billion-barrel Kaskida discovery made in 2006.
Even under the best of circumstances, it will be years before we're able to count that oil as actual supply, but its impact on prices is inevitable. The oil market is a classic example of supply and demand being mediated through price.
Because most of our oil supply resides below ground (or under the ocean), oil prices historically reflect shortage. More often than not, the oil price curve is inverted, or "backwardated." Backwardation occurs when futures are priced lower than the spot price. Since 1985, in fact, the average quarterly discount from the nearby NYMEX West Texas Intermediate [WTI] crude oil contract is 16 cents a barrel.
Why is this? Think of the ownership of oil reserves as granting a sort of call option to a producer. When futures are priced higher than spot prices—a condition called "contango"—a producer has the option of leaving oil in place, rather than bearing the costs of extraction and above-ground storage. If the majority of producers withhold oil, though, shortage is created, which in turn causes the spot or nearby delivery price to rise.
Thought of this way, you could say that weak backwardation is a necessary condition to stimulate current production.
Recently, though, the oil market's been characterized by contango, rather than backwardation. The WTI crude oil market slipped into contango back in June 2008, just one month before the crescendo (and denouement) of the oil run-up played out.
In fact, the shape of the WTI futures curve is a fairly good proxy—and some might say, a good predictor—of our oil inventory. Contango coincides with large inventories, while inversion accompanies smaller supplies.
U.S. Domestic Oil Inventory Vs. WTI Futures Curve
So does the present contango reflect an overabundance of crude? Historically speaking, yes. Since 1985, the domestic stockpile outside the Strategic Petroleum Reserve has averaged 323.6 million barrels. In May, supplies peaked at 375.3 million barrels. Some of that inventory has been worked off, but at last count in August, supplies were still above average at 343.4 million barrels.
Last year's flip into backwardation accompanied the most dramatic plunge in crude oil prices in history. As crude oil prices swooned, contango grew spectacularly, until it peaked in January 2009. When nearby oil traded at the $35 level, there was enough of a spread between nearby and deferred deliveries to allow a 40% net return for a three-month cash-and-carry trade.
In a carry trade, a trader purchases cheap spot oil and, at the same time, sells a futures contract at a higher (contangoed) price, thus locking in a guaranteed sale. After paying for storage, financing and insurance, a trader could have made as much as $14 a barrel by capturing oil's contango. Not surprisingly, oil inventories grew apace as carry trade operators vied for more and more storage capacity.
Market participants interpreted the rise in inventories as oversupply, which in turn pressured front-month futures downward. This contributed to the further widening of the contango.
Now, we're witnessing the unwinding of the contango. At least that's what oil bulls believe.
More than anything, the prospect of OPEC production cuts stabilized oil prices this year, bolstering crude's price and narrowing the market's contango. The spread between nearby and three-month distant futures is now less than $2 a barrel, and the carry trade is long-extinguished.
The question now is whether market participants will look upon a future drawdown in inventories as a reason to bid up nearby futures, further narrowing the contango.
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a Chavetic Venezuela. 2 Billion would great if the
Numbers are too optimistic. 2 Billion times $70+
a Barrel is alot of Money, even though the word
"Billion" has never gotten so much work as the last year.
I'm a Native Californian and I think we should drill off the Coast, but out of Sight of the Naked Eye.
If the Norwegians and British can drill safely in
the North Sea we can certainly do it in the "Calm Ocean". Throw a Dollar from every Barrel in the Social Security Fund so the benefit is widely shared.
Convert all Car and Truck Fleets to Natural Gas.
Over time it will become more practical for the
average driver to follow suit. Hybrids and Electric
also part of the Mix. So is smarter driving, i.e. not racing up to an "obviously" Red Light... which infuritates on a daily basis. Anyhew
As one Speaker on TV said at $40 a Barrel Putin and Chavez are Monkeys. At $90 Barrel they are Gorillas. He left out the Mullahs of Iran, pick your own animal analogy. :-)
We got to the Moon in 8 years starting from a place of "no idea" because we committed to it.
The Best Chance of Buying our Republic another 100 years is to stop exporting our Wealth for Energy, well that and educating our children better but thats another forum.
However, if you are the producer (lumber, oil, flooring, drinking water etc) of something and you find a major source of raw materials, could be 5% of use that is a big deal. To squash down the find into its finite terms of immediate use doesn't correlate to it's usefulness over the long term because it is spread out over time and augments current supply.
On Sep 04 02:33 PM bobbybutte wrote:
> this oil discoveryis important in the fact that america needs to
> drill for oil here why let a british company make all the profits.
> Like Exxon or not when they earn20 billion the Us govt gets 7 billion.
> all these massive deficits are driven because many companes are payinga
> reduced amount of taxes
Your instructive points are always worth restating and illuminating with changing conditions,and new insights , which you do very well, and the update is also well timed.
My question is : How do inventory taxes play into all this, and could they be used better to help smooth out the crude drilling /production cycle to assist in avoiding violent swings in supply - price?
Also, what else, if anything, could legitimately encourage and cause superior planning and oil supply to meet our oil needs "as needed ", and as "close as possible?"
BY SPENCER SWARTZ AND ALISTAIR MACDONALD
LONDON -- British oil giant BP PLC lobbied the U.K. in late 2007 over a controversial prisoner transfer agreement with Libya, and oil-rich Qatar lobbied Scotland on the case in June. Revelations of the efforts Friday fed speculation by opposition politicians and victims' families that the recent release of the convicted Lockerbie bomber is entangled with oil interests.
U.K. Prime Minister Gordon Brown has said the U.K. didn't pressure Scotland to free Abdel Baset al-Megrahi, the Libyan convicted of the 1988 bombing of a Pan-Am flight that killed 270 people. He has strenuously denied accusations by political opponents
Also, when money is present, so will there be politicians, lobbyist and big business.
www.opensecrets.org/
Combined with its $6.8 million outlay in the first quarter, Chevron spent about $12.8 million on lobbying in the first half of 2009, the fourth-highest tab for companies and organizations that file disclosure reports, according to data from the Center for Responsive Politics.
Chevron, the second-largest U.S. oil company behind Exxon Mobil Corp., spent $3.2 million on lobbying in the second quarter of 2008.
In the most-recent period, Chevron lobbied on a variety of issues, including legislation dealing with market speculation and manipulation and Federal Trade Commission rulemaking. It also weighed in on environmental matters and industry-specific issues such as hydraulic fracturing, according to the disclosure form filed July 17 with the House clerk's office.
Besides Congress, Chevron lobbied the departments of Energy, State, Commerce, Treasury as well as the Environmental Protection Agency and the Executive Office of the President.
Among those lobbying for Chevron were Lisa Barry, the former principal deputy assistant secretary at the Commerce Department, and Judy Blanchard, former deputy staff director for the House Committee on Oversight and Government Reform.
www.opensecrets.org/
Congress needs term limits.
On Sep 04 08:36 AM MPT failed wrote:
> Does this big discovery make you think that our theory of how oil
> is formed may be wrong? If it is from decaying vegetable matter,
> how many idfferent periods of forestation did the earth have and
> how far apart were they. Any geologists out there?
We are seeing nations moving away from the dollar and as it weakens, our dependence on imported oil will be revealed in higher prices even if there is more supply than demand.
The price is determined by the highest priced wells needed to meet demand, not the low price or even average price of wells.
If 95% of the oil comes from $10 wells, the price will be set by the 5% that comes from $40, $50, and $60 wells and oil sands projects. Take away that 5% and supply falls short of demand and the bids go up until it is profitable to pump the more expensive wells.
Because the dollar is eventually facing a major decline due to our deficits and nations moving away from the dollar, we will all pay the price of that devalued dollar in everything we import as well as oil. We will pay the price in everything, including food that is priced by global demand.
Gasoline prices just went up another 5% this past week.
On Sep 05 08:39 PM OilFinder wrote:
> Oil is mostly formed from decaying algae and plankton. All oil is
> ultimately aquatic in origin.
Because we are finding much more and in quantity, one leg on the Peak Oil table comes off and the table falls over.
I'm not saying we won't eventually hit a threshold of importance, I'm saying that the argument from a credibility perspective is critically flawed.
On Sep 04 12:22 PM swaps wrote:
> We are having to drill deeper and deeper, at ever greater expense.
>
>
> Peak Oil is still vindicated.
Toyota just delivered their second million Prius. Last week Saudi Prince Turki al-Faisal went on a tirade about American energy independance and how farsical it was. Consider this a contra indicator that conservation is a real and meaningful move to electrics etc is happening quickly. You can consider his commentary to be scared of the velocity of the move away from oil/gasoline. It's working, and it's working very very quickly.