Watch the spreads: Oil prices tumble before year-end
LONDON: Crude oil prices sold off heavily on Wednesday and Thursday, with front-month Brent futures falling more than 7 percent to the lowest level more two and half months.
Prices slumped amid growing concerns about continued oversupply in the market, the build-up of inventories and the possibility of storage space running on land and forcing more oil to be stored expensively at sea. The American Petroleum Institute reported on Tuesday that crude oil stocks in the United States rose by an unusually large 6.3 million barrels last week.
The Energy Information Administration confirmed on Thursday a build of 4.2 million barrels with inventories now 109 million barrels above the prior-year level.
There was plenty of other bearish fundamental news around, with OPEC predicting the oil market would remain oversupplied in 2016.
But prices have also been influenced by more technical factors, among them the expiry of the December Brent futures contract today which tends to reduce liquidity and exaggerate price movements.
WATCH THE SPREADS The most interesting prices moves were not in spot prices but in the differences or spreads between futures contracts expiring on different dates (http://tmsnrt.rs/1N1eOd1).
The entire strip of futures prices for the next six months has been weakening over the past four weeks as the market focus swings back from strong oil demand towards continued oversupply.
Softness in the spreads for both WTI and Brent futures contracts has been especially pronounced over the last 10 days. But much of the weakness has been concentrated in the contracts nearest to expiry in December rather than further forward in 2016.
For both Brent and WTI, the spread between contracts expiring in December and January weakened much more than the spread between contracts expiring in January and February.
The main move in WTI occurred late last week, with Brent catching up on Thursday.
The sudden weakness in the December Brent and WTI contracts likely has more to do with technical factors than fundamentals. Front-month futures contracts often exhibit strange behaviour in the run up to expiry as positions are rolled forward and liquidity shifts to the next-nearest contract.
The spread between December and January contracts is particularly unusual because it covers the period over yearend. Many businesses minimise physical inventories they own over the yearend for accounting purposes by agreeing to sell them before December 31 and buy them back in January.
There is an active market for yearend sale and repurchase transactions and plenty of intermediaries in the market will arrange them, with associated need to juggle hedges and futures positions. The sudden shift in the December-January spread for both WTI and Brent therefore comes as no surprise and probably has more to do with the shifting of futures positions and hedges rather than fundamental news. In turn, the sudden drop in spot prices over the last couple of days probably reflects technical changes in the spreads at the front of the curve rather than a big shift in supply and demand fundamentals. — Reuters