uploads/2017/09/image003-6.png

How Harvey and Irma Affected the Futures Spread amid Supply Glut Worries

By

Updated

Futures spread

On September 12, 2017, US crude oil (DBO) October 2018 futures settled at $2.09 above the October 2017 futures. On September 5, 2017, the futures spread was at a premium of $1.94. From September 5 to September 12, 2017, US crude oil active futures fell 0.9%.

Article continues below advertisement

What happens during contango?

During contango, the futures spread is at a premium. For example, in the trailing week, the futures spread was at a premium, as we discussed above. If the premium rises, oil prices could fall.

For example, the premium rose as high as $12.01 on February 11, 2016. On the same day, US crude oil active futures closed at their 12-year low. However, any contraction in the premium could support oil prices.

During backwardation

During backwardation, the futures spread would be at a discount. If the discount rises, oil prices could rise. For example, the discount rose as high as $10.53 on June 20, 2014.

On the same day, US crude oil active futures closed at their high of $107.26 per barrel, just before the three-year downturn in oil prices started. However, a fall in the discount could erode oil’s gains.

In the seven calendar days before September 12, 2017, US crude oil prices fell as the contango spread expanded. Hurricane Irma, which hit Florida on September 10, 2017, could reduce gasoline demand.

Also, refineries on the Gulf Coast have not fully recovered from the damage wrought by Hurricane Harvey. Both factors could have increased concerns regarding increasing crude oil stockpiles. Increasing stockpiles are a bearish factor for crude oil prices.

However, if the factors pushing stockpiles higher do indeed turn out to be temporary, the expansion of the contango spread and the pressure on crude oil prices could also prove to be temporary.

Article continues below advertisement

Energy subsector stocks

US crude oil producers (XOP) (DRIP) track the shape of the forward curve of oil futures, which is important for their hedging-related decisions. It also impacts midstream (AMLP) oil transportation and storage businesses. Mainly, the shape of the futures forward curve can present opportunities to store oil and sell at a future date at higher prices, or lock in higher prices at a future date for expected production.

On September 12, US crude oil futures contracts for delivery until December 2018 settled at progressively higher prices compared to active futures. Because of this upward sloping futures forward curve, ETFs that follow US crude oil futures such as the United States Oil Fund LP ETF (USO) could yield lower returns compared to crude oil.

For ongoing updates on oil prices, please visit our Energy page.

Advertisement

More From Market Realist