Continuing the discussion from yesterday’s issue of regarding the signal the Nymex forward curve is sending, the contango on the front of the Board moved out to over $3 (!) or minus 3½%. Thus, with the term structure offering such a hefty carrot to take barrels off of the spot market, the signal is clear, the deepwater horizon incident notwithstanding, traders anticipate that supply will outstrip demand in the near-term.
One offshoot of this move means that the odds are rapidly lengthening of a reversion in the ICE Brent/Nymex WTI spread before the June Brent contract expires on May 14th. We already commented that the logic employed by the Street’s cognoscenti is technically correct, i.e. rising oil stocks at the Nymex delivery point in Cushing, Okla. will be alleviated by rising refinery utilization ahead of the summer driving season.
Unfortunately, Brent’s premium to WTI does not come with an expiration date. To wit, recent historical metrics ( – April 22, 2010) demonstrate that this spread could remain illogical longer than you can remain solvent. More importantly, extant fundamentals suggest that WTI’s discount to Brent could linger longer than most on Wall Street believe possible.
First and foremost, the risk posed by Horizon is a closure to GoM shipping lanes which will disrupt deliveries into PADD III refineries. At this point, the likelihood of such an event (on a scale that will cause a material disruption to refinery activity) seems remote. But just in case the unlikely becomes likely, there are 727 MMbbls (75 days of import cover) sitting down in the Gulf in the SPR for just such a contingency.
At the same time, inventories up the pipe at the Nymex hub in PADD II are near all-time highs and the Nymex curve is paying a bounty to keep this storage at capacity. Therefore, where are incremental barrels (if not from the GoM, than at least from Canada) going to go if tankage is unavailable to store?
Those barrels will have to get dumped on the market, thereby depressing the front of the Nymex curve even further. Additionally, as of a week ago yesterday institutional investors (managed and pension funds) owned nearly 5 paper barrels for every 1 physical barrel now sitting in Cushing.
Given that Ivy League endowment funds et al. are not about to get their hands dirty and go to delivery with their contracts, they are going to have to roll their length. In turn this event could potentially keep spot barrels at the offer and install a bid in the back of the curve. In other words, the contango on the Nymex is currently self-perpetuating by virtue of Wall Street’s best-and-brightest [sic] and limited storage capacity in Cushing.
As far as the latter goes, the Brent market, which is a marker for Middle East and African crudes, is not hindered to the same degree of storage capacity.
Thus, while demand for barrels in Cushing will rise in the coming weeks, the contango provides a tremendous incentive to replenish those barrels immediately. Therefore, while the Nymex contract will eventually revert back to a premium to Brent in the long-term, there is no pressing reason why it has to revert in the near-term.
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Stephen Schork is the Editor of and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.