Knzn asks about the significance of the shift from contango to backwardation in the term structure of crude oil futures. I think one thing it signifies it that some OPEC spokesmen are simply blowing smoke.
Reuters reported last week:
More crude supply from OPEC would do little to ease $80 oil as speculative investment flowing into the market from other assets is boosting the price, Qatar’s oil minister said on Monday….
“I am confident that the price is not related to supply,” Qatar’s Oil Minister Abdullah al-Attiyah told Reuters by telephone. “We increased at the last OPEC meeting and were confident that it would help the market, but unfortunately the market is moving in a different direction. More oil won’t help at all.”
To evaluate this claim, consider first what the market for oil would be like if there was never any speculation. The quantity demanded and quantity supplied would both be functions of the price, and equilibrium would require a price at which the two would be equal.
If speculators perceive that a higher price may be coming in the future, they might be able to profit by buying some oil for storage now and selling it at the higher price in the future. In this case, some of the oil that is being produced today would not go to satisfy current demand, but instead would be used to increase inventories. With less oil available to satisfy current users, the current price would be bid up. By this mechanism, the actions by speculators could cause the price to be higher than it would have been otherwise.
If the futures price (a price agreed to today at which oil will be purchased at some future date) is sufficiently above the current spot price (a situation described as contango), this can actually be a risk-free investment, as the speculator can sell any oil that goes into storage at a guaranteed high price. As discussed in the Wall Street Journal article noted by Knzn, the contango in oil futures markets last year provided a strong incentive for holding inventories. Over the last few months, however, the near-term oil futures price has risen more quickly than the farther out prices, moving us into the current situation of backwardation. In the current environment, anyone buying oil for speculation and selling forward at today’s futures prices would in fact be locking in a loss.
Instead a more natural reading of the current situation is that the market is still anticipating the effects of the modest increase in Saudi oil production that has been promised as part of the recent increase in OPEC quotas. Assuming that arrives on schedule, it could start to bring some relief to oil markets. But until it does, prices will remain tight.
The real story remains as it has been– the demand for oil remains strong, and increases in production have not been very significant. That reality is what has been driving oil markets all along.
Maybe you believe that the price of oil has nothing to do with the quantity of oil that OPEC produces. Or maybe you believe that the declarations of OPEC ministers sometimes have nothing to do with the facts.