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Global oil market in contango amid concerns of oversupply and weak demand

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2023-11-17

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The global oil market has shifted into a state of contango, where future prices trade at a premium to spot prices. This change signals growing apprehensions about demand in 2024 and an oversupply issue.

For the first time in four months, oil futures prices have entered contango, but this situation was short-lived, and the price curve returned to the more common backwardation, where spot prices are higher than prices for future delivery.

Contango encourages traders to buy and store fuel, similar to the way an inverted bond market yield curve serves as a warning signal. Both situations are considered negative indicators. An inverted yield curve has intermittently appeared in bond markets over the past year or more and is often seen as an early sign of an impending economic slowdown, although the U.S. has not experienced a recession during this time (unlike Germany and the UK, briefly).

On Thursday, U.S. West Texas Intermediate crude prices fell by 5%, trading around $72.90 a barrel in early Asian dealings. Brent crude also dropped by around 5% to approximately $77.45 a barrel for the day.

Analysts and traders, who predicted two months ago that oil could reach $100 per barrel by next month, are now driving the price downward as they close their positions to avoid significant losses.

Thursday witnessed U.S. West Texas Intermediate's front-month contract trading as much as 23 cents lower than the second-month contract, and up to 29 cents lower than prices for purchases six months out. Brent also entered contango on Thursday, with the front-month contract trading 13 cents lower than second-month prices.

Weak economic data from China has negatively impacted sentiment, and the latest U.S. government data showing a rise in U.S. crude inventories and a record daily production estimate of 13.2 million barrels a day have contributed to the decline.

Prices have continued to slide despite Saudi Arabia and Russia maintaining their 1.3 million barrel production cut until the end of the year. With the market weakness, there will likely be added pressure for more significant cuts in the first quarter of 2024 when OPEC meets on November 26.

The oil market has not maintained its initial bounce since the start of the Hamas-Israel conflict on October 7.

However, it was the reversal of the situation at the Cushing, Oklahoma, oil storage hub that triggered the shift to contango. Cushing serves as the delivery point for all U.S. oil futures trading, and there were concerns a month ago that there might not be enough oil in storage to cover purchases.

The drop in prices follows the Energy Information Administration's weekly report, which indicated a 3.6-million barrel increase in inventories last week, bringing the two-week rise to 17.5 million barrels. U.S. production remains at a record 13.2 million barrels per day, 1.1 million bpd above the previous year's level.

Phil Flynn, an analyst at Price Futures Group, stated, "We have seen significant increases in Cushing, taking away the fear of a supply squeeze." He added, "All the people that were in that trade are going the other way," according to Reuters.

In addition to these factors, U.S. refiners have reduced production runs, and oil exports have reached nearly 5 million barrels per day in the latest week. Both of these factors contribute to the sentiment that there are no significant supply concerns.

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