On October 10, 2017, US crude oil (USO) (DBO) (OIIL) November 2018 futures traded $0.46 higher than November 2017 futures. The difference between the futures contract is called the “futures spread.” On October 3, 2017, the futures spread was at a premium of $0.33. In other words, the November 2018 futures traded $0.33 more than the November 2017 futures. Between these two dates, US crude oil November futures rose 1%.
In a contango situation, the futures spread will be at a premium. When the premium expands, oil prices could retreat. Moreover, any contraction in the premium may add gains to oil prices.
For example, on February 11, 2016, US crude oil futures closed at their 12-year low. On the same day, the premium spiked to $12.01.
In a backwardation scenario, the futures spread is at a discount. When the discount expands, oil prices could advance. Moreover, any contraction in the discount may make oil prices fall. For example, on June 20, 2014, US crude oil futures closed at their high before more than a three-year downturn in oil prices. On the same day, the discount spiked to $10.53.
In the trailing week, the contango expanded, but US crude oil prices gained. So, oversupply concerns are still looming. In part one of this series, we discussed the factors that could be behind oil’s rise.
The crude oil futures forward curve is vital for US oil producers’ (XOP) (DRIP) (IEO) hedging decisions. In a wide enough contango, oil producers could find selling current production at a future date profitable. These aspects are also important for midstream (AMLP) oil transportation and storage companies.
On October 10, 2017, US crude oil futures contracts for delivery until May 2018 settled at progressively higher prices. With the upward-sloped futures forward curve, ETFs that are meant to track US crude oil futures could underperform active crude oil futures. These funds include the United States 12 Month Oil Fund LP (USL), the United States Oil Fund LP ETF (USO), and the ProShares Ultra Bloomberg Crude Oil ETF (UCO).
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