Backwardation Suggests Oil Fundamentals Remain Tight

Oil prices remained under pressure in European session, being dragged down by the vulnerable stock markets due to Greece's woes. The front-month contract for WTI crude oil fell for the third consecutive day, slipping to 4 day low at 85 at one point, while the equivalent Brent crude contract weakened to as low as 110.42. Dependent on the general market sentiment, oil prices are susceptible to further decline in the near-term. However, futures curve structure suggests that the demand/supply outlook in the market remains tight.

The chart below shows that Brent has returned to backwardation (crude for nearby delivery costs more than crude for the future) in recent months. The same situation is experienced by Oman crude in August. Although WTI crude has remained in contango but time-spreads have also strengthened. We are impressed by the fact that time-spreads strengthened during the period of IEA's release 60 mmb of emergency reserve with the US responsible for half of it.

According to the latest US inventory report, US SPR has fallen 29.59 mmb in the 7 weeks beginning July 22. During the period, total crude oil and SPR inventory dropped -28.23 mmb, signaling little change in crude inventory despite release of the SPR. The phenomenon indicates that the release of the SPR has been absorbed by the market. That said, tightness in oil fundamentals was probably due to the decline in imports, instead of strength in demand. Note that net imports for crude oil dropped more than -1 mmb over the past few weeks.

In Europe, oil supply disruption persists. While Libya's oil is expected to return to the market in coming months, only about half of the original production will be resumed by the end of 2012 and full production of 1.6M bpd may not be seen 3 years later. Shell's force majeure on Bonny light exports and sanctions on Syria only exacerbated the demand/supply balance.

Commitments of Traders:

With the exception of natural gas, speculators were bullish on the energy complex in the week ended September 2. Net length for crude oil futures soared to 165 142 contracts. Net lengths for heating oil futures and gasoline futures rose to 15 575 and 53 774 contracts respectively. Net short for natural gas futures increased to 183 017 contracts during the week.

Speculators were bullish on the precious metal complex. Net length for gold futures climbed for the first time in 5 weeks, gaining +7 424 to 184 371 contracts. Net length for silver futures also rose to 27 207 contracts. For PGMs, net lengths for platinum and palladium futures increased to 28 008 and 12 637 contracts, respectively, during the week.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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