Futures Spread: Why Oil Is Looking Stronger

Futures spread

On October 24, 2017, US crude oil December 2018 futures closed $0.8 below December 2017 futures. The difference between the two futures is called the “futures spread.” So, on this day, the futures spread was at a discount of $0.8. On October 17, 2017, the futures spread was at a discount of ~$0.5. In the past five trading sessions, US crude oil futures rose 0.7%.

Futures Spread: Why Oil Is Looking Stronger

Backwardation

The futures spread at discount can be seen in a state of the futures forward curve called “backwardation.” When this discount rises, oil prices may rise. Conversely, any fall in the discount could add bearishness to oil prices. For example, on June 20, 2014, the discount was at $10.53. On the same day, US crude oil active futures were at their highest closing level before the over three-year bearishness in oil prices started.

Contango

The futures spread at a premium can be seen in a state of the futures forward curve called “contango.” When the premium rises, oil prices may fall. Conversely, any fall in the premium could add bullishness to oil prices. For example, on February 11, 2016, the premium was at $12.01. On the same day, US crude oil active futures were at their lowest closing level in the last 12 years.

In the trailing week, the backwardation expanded. US crude oil futures rose during that same period. It may signal a reduction in global oil supplies that has spooked the oil market in the last three years. It could also be significant for the equity indexes such as the S&P 500 Index (SPY) and the Dow Jones Industrial Average Index (DIA) because oil is a growth-driven asset.

Energy stocks

US oil producers’ (XOP) (DRIP) (IEO) hedging decisions could depend on US crude oil futures’ forward curve. During backwardation, oil producers may opt to sell current production at the current prices for more profit rather than storing it and selling it at a future date. The curve is similarly vital for midstream (AMLP) oil transportation and storage businesses.

On October 24, 2017, US crude oil futures contracts for delivery until April 2018 settled at progressively higher prices. Because of the upward-sloping futures forward curve, ETFs that are meant to track US crude oil futures may underperform oil futures. The upward sloping curve could be behind the underperformance of the United States 12 Month Oil ETF (USL), the United States Oil ETF (USO), and the ProShares Ultra Bloomberg Crude Oil (UCO) in comparison to US crude oil futures.