uploads/2017/11/P1-8.png

Are Oil Oversupply Concerns Letting Up?

By

Updated

Oil’s futures spread

On November 21, US crude oil January 2018 futures closed at a premium of $2.6 over January 2019 futures. This difference is known as the “futures spread.” On November 14, the futures spread was at a premium of $1.6. Between November 14 and 21, US crude oil active futures rose 1.7%.

Article continues below advertisement

What are backwardation and contango?

Any rise in the premium, or expansion in the “backwardation,” could benefit oil prices. On November 6, US crude oil active futures closed at their 2017 highest closing price. On the same day, the premium rose to $2.31. But a fall in the premium may risk oil prices.

The spread in a discount is called “contango.” A rise in the discount, or an expansion in the “contango,” could threaten oil prices. On June 21, US crude oil active futures closed at their lowest closing price in 2017. On the same day, the discount rose to $2.6. But a fall in the discount may also benefit oil prices.

Oversupply concerns easing?

Between November 14 and 21, the rise in the premium could suggest the easing of oversupply concerns. US crude oil futures rose between these two dates. The factors that supported oil prices were already highlighted in Part 1 of this series. Oil’s supply-demand dynamics could also influence the S&P 500 Index (SPY) and the Dow Jones Industrial Average Index (DIA).

The energy sector

The futures spread at a premium could encourage US oil producers (XOP)(DRIP)(IEO) to engineer different risk management techniques compared to if the futures spread were at a discount. For hedging their output, US crude oil producers follow US crude oil futures’ forward curve. This curve also drives midstream companies’ (AMLP) oil transportation and storage decisions.

On November 21, US crude oil futures contracts between January and March 2018 were priced in ascending order, which could mean a reduction in returns for ETFs like the United States 12 Month Oil ETF (USL), the United States Oil ETF (USO), and the ProShares Ultra Bloomberg Crude Oil (UCO). These ETFs invest in US crude oil futures.

Advertisement

More From Market Realist