19 Apr

Oil’s Contango: Is It Bullish for Traders?

WRITTEN BY Rabindra Samanta

Contango and oil prices

On April 18, 2017, June 2017 crude oil (DBO) (OIIL) (USL) futures were trading at a discount of $1.15 to June 2018 futures contracts. The situation, which is referred to as “contango” in the crude oil futures market, is represented by an upward sloping shape on the futures forward curve.

Oil’s Contango: Is It Bullish for Traders?

The structure indicates that there’s market sentiment toward weak crude oil demand right now. Historically, periods of weak crude oil prices coincided with the contango structure. The crude oil forward curve switched to a contango structure in November 2014. Since then, crude oil active futures have fallen ~33.5%.

Backwardation and oil prices

On the other hand, when there’s immediate demand for crude oil, active crude oil futures trade at higher prices than the futures contracts for the months ahead. It causes the crude oil futures forward curve to slope downward. The situation in the crude oil futures market is referred to as “backwardation.”

Historically, periods of strong crude oil prices coincided with a backwardation structure. Crude oil (SCO) (UCO) (DWTI) active futures closed at a historic high of $145.29 per barrel on July 3, 2008, after an almost one-year period of backwardation in the oil market.

Active crude oil futures traded at a premium of $9.77 to futures contracts 12 months ahead at the peak on November 2, 2007. As the forward curve switched to contango over the course of the following year, with active futures hitting a discount of $24.45 to futures contracts 12 months ahead in January 2009, crude oil prices fell 75.6%.

So, the shape of and changes in the futures forward curve in the oil market could hint at coming changes in oil prices.

Crude oil forward curve dynamics

After OPEC’s (Organization of the Petroleum Exporting Countries) historic deal in November 2016, the contango structure in the oil market started to flatten. On February 23, 2017, WTI (West Texas Intermediate) crude oil active futures were at the highest levels since July 6, 2015.

Due to rising US oil production and record oil inventory levels, the spread started to widen on February 23, 2017. Since then, crude oil has fallen 2.9%. In the past week, crude oil prices fell 1.7% as the spread rose from $0.67 to $1.15.

The crude oil forward curve’s dynamics can have implications on oil storage MLPs (AMLP). The dynamics can impact upstream oil producers’ (XOP) hedging decisions. The rise in the contango spread could point to rising concerns about crude oil’s demand-supply imbalance. It could mean that the market sees lower prices coming in the spot crude oil market.

The curve’s dynamics also have important implications for the performance of commodity tracking ETFs such as the United States Oil ETF (USO). Due to the contango structure in the oil market, USO underperformed crude oil prices. However, that could change if the oil market switches to backwardation.

Latest articles

Goldman Sachs (GS) settled a lawsuit that alleged it rigged bond prices. Also, Deutsche Bank agreed to pay a fine of $15 million to settle a lawsuit.

In the November 15 premarket trading session, Amarin Corporation (AMRN) stock rose more than 7%, caused by the FDA positive decision for Vascepa.

In the November 14 trading session, Aurora Cannabis (ACB) stock fell 12.7% from the previous session during after-hours trading.

Strategy Analytics reported that Apple could lead the 5G smartphone market in 2020, outshining Samsung—the current leader in the global 5G market.

This week has been tough for the cannabis sector. Cronos Group and Canopy Growth reported lower-than-expected earnings, and the sector ETFs dropped.

Yesterday, Argus Research upgraded Uber stock from “hold” to “buy.” Let's look at Uber and Lyft’s recent analyst rating changes.