Crude Oil Backwardation

By Tom McClellan

Crude Oil Backwardation

For the first time since oil’s big price collapse in 2014, the crude oil futures are now back into “backwardation”.  That is a condition where the near month contract is priced at a higher level than the farther out month contracts.  And it is a condition usually associated with price tops.

For the entire uptrend from crude oil’s 2009 price low to its 2011 top (which interestingly coincided with Osama bin Laden being killed), oil futures were in strong “contango”, which is the opposite of backwardation.  That top also coincided with a return to backwardation.  Later, in 2013-14, we saw huge backwardation, which showed the stress that the crude oil market was under given the new supply from U.S. shale oil producers.  That stress finally broke the oil market in 2014 when OPEC could no longer maintain high prices through its own production cuts.

That sharp drop in 2014-15 took oil futures back to a strong contango condition in early 2015, marking a preliminary bottom, and then again in early 2016 which marked a more permanent one.  As oil prices have chopped sideways between around $45 to $55 per barrel, the spread in this week’s chart has been creeping back upward again.

Arriving at a backwardation condition now does not mean that oil prices have to start downward right away.  But it does say that expecting more upward movement is going against the message of the futures market.  Oil producers are happy to sell their future production at roughly the same prices as we see today in the spot and near month markets.  That means they think they can continue to produce profitably at this price.

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