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Indicators For Oil: Inventories And Oil Futures Curve

Sep. 06, 2015 10:47 AM ETOIL-OLD, USO
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Summary of the article:

  • Oil price moves inversely with slope of futures oil curve (implied % cost of oil storage); now there is small divergence between them
  • During crisis periods for oil (2008-2009 and 2014-2015 years) implied % cost of oil storage spikes up both with oil inventories and then they move toghether some period
  • Inventories in refining products (gasoline and distillate fuel oil) tend to drive crude oil inventories with about 2 month lag

As we all know, for commodity futures there is a relationship between spot and futures price: Futures = Spot * (1+ risk-free rate + % cost of commodity storage). This relationship is straightforward and simply reflects the fact that cost of holding physical commodity includes both time value of money and and cost of storage. It's also clear that when implied % cost of oil storage is high, oil futures curve is steep, and vise versa.

I've checked this futures-spot relationship and calculated 1Y implied % cost of oil storage, using 1Y and nearest 1M WTI futures prices and 1Y Libor as risk-free rate. The result is that oil price moves inversely with implied % cost of oil storage, and this inverse relationship is strong (last 10y monthly correlation is -0,68) and stable. The explanation here is that implied % cost of oil storage serves function of market sentiment on inventories: when implied storage cost is high, market thinks that there are a lot of oil inventories, implying oil oversupply and driving price lower, and vise versa.

Implied % cost of oil storage starts to trend down both with end-August oil rebound, decreasing from about 16% to 10,2% at 31 August. What's interesting is that these Septmeber days implied cost of storage diverges with oil: oil has lost some of its end-August gain, while cost of storage continues to decrease a bit. Moreover, as we can see from the graph, recent oil lows have much lower implied cost of storage than February-March lows. So, it can be a sign that market has shifted in some degree it's outlook on inventories and demand-supply imbalance, implying less dramatic future situation for oil.

By the way, does implied % cost of oil storage depends on oil inventories levels? Generally not a lot, but during crisis period for oil (2008-2009 and 2014-2015 years) both inventories and implied cost of storage spike up and start to correlate good during some period. So these days, when crisis time hasn't yet finished for oil, implied % cost of oil storage should be tracked as a good predictor for change in oil inventories in the future. As we can see again, after correlating good during last 12 months, August was the first moth when correlation was broken a bit.

Continuing inventories topic, there is one way to predict change in oil inventories. Change in oil inventories is driven with lag by change in oil refinery inventories - gasoline and distillate fuel oil (their sum); the best lag I've found is 2 months. The explanation here is that when refinery inventories are big, they bid less oil next months, which makes oil suppliers to do higher inventories next month, and vise versa. July change in oil refinery inventories was +6.1 mln barrels with August data +2.6 mln barrels, so in short term I expect oil inventories to grow in September-October. However, in the long term EIA specilaists forecast oil inventories to decrease, and i don't have any arguments to disagree with them.

So, to sum up my small oil research, I'll say that I haven't come up yet with idea how to trade my research this second, but i hope i've provided readers with implied % cost of oil storage cost and other indicators of oil market, which they can track to better uderstand what is going on with oil. Now these indicators state that market sentiment on oil has become less stressful and bearish, but we need further evidence to state surely that sentiment has shifted.

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