Schork Oil Outlook: A Supply/Demand Imbalance

Pending imbalance in supply/demand equation for crude oil?

Last night (Tuesday), the Nymex WTI crude oil Q4 2010 strip closed at a $3.81 or 4.8% discount to the Q1 2011 strip. A month ago, this contango was only $2.17 or 2.9%! So much for market concerns regarding pending tightening in the supply/demand balance in the second half of 2010? After all, if imbalances in supply were manifest, the market would pay you (backwardation) to take barrels out of storage, not the reverse.

However, as highlighted in yesterday’s issue of The Schork Report, at any given time — like now — geography, quality and/or the uncertainty of capacity issues at the Nymex delivery hub in Cushing, Okla., can distort the normal relationship along the Nymex crude oil curve.

For example, last night, the November Brent contract closed at a $0.33 discount to the December. The corresponding spread in New York finished at a $1.68 discount.

In other words, the gradient in the slope of the contango is greater in New York. Therefore, given that the London contract is a better indicator of the market’s perception of global supply-demand balances; does the smaller gradient in the Brent contango indicate concern for the future availability of crude oil on a global scale?

Perhaps, and therefore it bears watching. On one hand the contango between the Dec’10 and Jan’11 (the end of Q4, start of Q1) has narrowed from around 60 cents to around 30 cents. That would seem to indicate concern as the market is more willing to pay-up for spot material. On the other hand, the market is still in contango.

Consider that the last time the UK was a net exporter of crude oil was in 2004. Today, the EU’s largest oil producer is a net importer. As illustrated in the Chart of the Day in today’s issue of The Schork Report, in 2004, even with the UK’s production in surplus, the Brent curve was in backwardation. The market was paying a premium to induce barrels out of storage… presumably because there was an imbalance (perceived or real) with demand relative to supply.

Now compare the current structure of the Brent market. Despite alleged concern of supply/demand imbalance, the market is still in contango, albeit not as severe as in New York, but contango nonetheless.

Bottom line, not until we see the crude oil market shift into backwardation will we become convinced of a shift in the balance between supply and demand.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.