US Oil Contango Vanishing as Supply Glut Shifts Abroad

The U.S. oil market is on the brink of returning to a more bullish footing known as backwardation for the first time in six months, with the discount for prompt supplies vanishing as a domestic supply glut eases.

 

The discount for prompt U.S. oil futures versus the second-month contract - a structure known as "contango" that signals a weak market - narrowed to its smallest in five months on Friday as strong demand and flattening production added to expectations that domestic stockpiles will continue to fall over the summer.

 

If that spread flips to a premium, known as "backwardation," it would come in sharp contrast to the global Brent futures , which is showing no signs of emerging from its 50-cent contango. On Thursday a prompt cargo of Forties crude, part of the European benchmark, traded at its lowest in 6-1/2 years.

 

The prompt-month July contract for U.S. West Texas Intermediate (WTI) crude was 27 cents lower than second-month August at 1:35 p.m. EDT (1735 GMT). That was the narrowest spread since Dec. 19. A month ago it was at a $1.50 discount.

 

Oil futures typically trade in a contango structure when immediate supplies are in surplus; backwardation indicates a feared shortage.

 

The vanishing contango means fewer incentives to store oil for later sale. Earlier this year, traders were racing to fill up tanks in Cushing, Oklahoma, to cash in on a nearly risk-free storage trade when the 12-month contango reached around $12 a barrel. Now oil in a year's time is only some $2 higher.

 

The U.S. Energy Information Administration (EIA) said on Thursday domestic crude inventories fell by 2.8 million barrels last week, down for the fourth week in a row before Monday's Memorial Day holiday, which unofficially kicked off the peak summer driving season in the United States.

 

The stock decline announced by the EIA was beyond a 857,000-barrel draw forecast in a Reuters survey and in contrast with a build of 1.3 million barrels estimated by the American Petroleum Institute.

 

"If you continue to see weekly draws like this, you will continue to see a weakening in the WTI contango," said Bob Yawger, director of energy futures at Mizuho Securities in New York.

 

Spot WTI jumped almost 5 percent on Friday, its biggest daily gain in six weeks, driven by the EIA data and a pause in the U.S. dollar's rally.

 

But oil bears caution that the spot price could come under pressure again on broader implications from the global oil glut. The dollar's recent gains have also weighed on oil, which becomes costlier for users of other currency when the greenback rises.