Wednesday, June 20, 2012

Crude Oil Inventories Rise to Record Levels But Futures Remain in Backwardation (WTF)

Not WTI but WTF, phonetically Whiskey-Tango-Foxtrot?
First up, the big picture, from Bespoke Investment Group:


And from FT Alphaville:

Scarcity amid plenty, oil edition
Like us, Reuters’ Robert Campbell has been pondering the paradox of backwardation in an oil market that appears to be plentifully supplied.
We missed his article when it originally came out last week, but think it’s worth taking a late look — especially since it complements our abundance series so well, and supports our views on artificial scarcity in commodity markets.
So here’s the paradox as he identifies it:
VIENNA, June 14 (Reuters) – How can oil fall 25 percent in a matter of months when the principal futures market has signaled all along a situation of dearth, not plenty? Or put another way, why have buyers of oil this year been paying a premium for prompt delivery when supply has far outstripped demand? Front-month Brent crude futures have traded at a premium to contracts for delivery two and three months later every single day but one this year.
This market structure, known as backwardation, is generally interpreted as a bullish signal of tight supply. When near month prices are higher than longer-dated prices, holders of inventory have an incentive to sell stocks into the market.
In other words, the market is signaling that it needs to draw down inventory to meet prompt demand.
But the oil market has been building stocks all year.
This is the paradox. How did the futures curve retain this shape when the global oil market was oversupplied relative to prompt demand?
Why was the futures market signaling to holders of inventory to sell stocks at precisely the moment when they were building stocks?
Contradictions FT Alphaville has been pondering too.
Indeed, this is what we wrote in December with respect to backwardation’s weird return...