The oil market just did something it hasn’t done for nearly three years

Key Points
  • Traders are paying more for oil on immediate delivery
  • Oil prices have risen for four consecutive months
  • Improved OPEC compliance is driving the oil price higher

Oil traders just provided another sign that the market is rebalancing.

The calendar spread for the next six months moved from "contango" into "backwardation" Tuesday. To explain, a calendar spread measures the difference in price between any pair of oil contracts with different delivery dates and can explain the current supply-demand balance in the market.

These oil futures contracts are financial instruments that carry legally binding obligations — so a buyer and a seller have the obligation to take or make delivery of an underlying instrument, such as oil, at a specified settlement date in the future.

In this particular case, the spread or measure is of the next month's oil contract against another in seven months from now. This is otherwise known as the 6-month spread, and currently underscores a growing level of immediate demand for WTI crude as inventories shrink.

According to Reuters data, it is the first time this measure has slipped into "backwardation" since November 20, 2014.

Backwardation is when the current price of oil is higher than a future cost of oil. It is seen as a sign of higher immediate demand. Conversely, contango is when the futures price of oil is higher than the spot delivery price.

As the chart below indicates, WTI has just moved into backwardation, while — on the same 6-month spread basis — moved into backwardation earlier this year.

Reuters | John Kemp

Oil prices extended gains in early trade Tuesday after fresh data revealed that oil cartel OPEC had improved its level of compliance considerably.

A Reuters survey for October released Wednesday estimated that 11 oil producing nations had achieved 92 percent compliance with supply caps previously agreed by OPEC. This number has risen from the 86 percent compliance measured in September.

Dwindling exports from northern Iraq has helped to push prices up further recently. Iraq curtailed its output by 120,000 barrels per day in October after its military retook control of oil fields from Kurdish forces.

The oil price gained 7 percent in October, marking the fourth consecutive month of gains.

The price of oil collapsed from near $120 a barrel in June 2014 due to weak demand, a strong dollar and booming U.S. shale production. OPEC's reluctance to cut output was also seen as a key reason behind the fall. But, the oil cartel soon moved to curb production — along with other oil producing nations - in late 2016.

Reuters contributed to this article.