On November 14, 2017, US crude oil December 2017 futures closed at a premium of $1.2 over the December 2018 futures. The difference is called the “futures spread.” On November 7, 2017, the futures spread was at a premium of $2.1. On November 7–14, 2017, US crude oil active futures fell 2.6%.
Backwardation and Contango
When the futures spread is at a premium or the premium rises, oil prices could rise. On November 6, 2017, the premium rose to $2.31. On the same day, US crude oil futures were at the highest closing price in 2017. If the premium falls, it could signal weakness in the market expectations for oil prices.
When the futures spread is at a discount or the discount rises, oil prices might fall. On June 21, 2017, the discount rose to $2.6. On the same day, US crude oil futures were at the lowest closing price in 2017. A falling discount could indicate bullishness in the market.
Are oversupply concerns rising?
In the trailing seven calendar days, the fall in the premium might suggest that oversupply concerns are rising in the oil market. Oil prices fell during this period. We discussed the fundamental angle of the demand-supply balance in Part 1 of this series. Oil’s oversupply concerns can also trouble broader market indexes like the S&P 500 Index (SPY) and the Dow Jones Industrial Average Index (DIA).
Oversupply concerns impact the energy sector
If the futures spread premium shifts to discount, US oil producers (XOP) (DRIP) (IEO) could implement different risk management techniques. The US crude oil futures’ forward curve is a key factor for US oil producers to consider when hedging their future output. The same might also be key to midstream companies’ (AMLP) oil transportation and storage operations.
On November 7, 2017, US crude oil futures contracts for delivery until April 2018 settled in ascending order.
US crude oil futures contracts between December 2017 and April 2018 at progressively higher prices can also mean that ETFs that take exposure to active US crude oil futures, like the United States 12 Month Oil ETF (USL), the United States Oil ETF (USO), and the ProShares Ultra Bloomberg Crude Oil (UCO), might incur losses when they roll their holdings over each month.
Visit Market Realist’s Energy and Power page for more update on oil prices.