Consider seasonal strips and spreads within those strips; Summer, Winter, Fall and Spring. Also consider that sometimes participants must "buy / sell", regardless of price, to re-balance. I think you're smart enough to figure out the rest.
Any further insights on the current shape of the curve? Crude has continued to decline while the spread is stuck in Backwardation. Is this possibly still a seasonal thing or something? Or is there some other underlying reason?
The backwardation is normal given the massive need of Fracking Oil producers in USA to hedge their expensive production over their well's 2-3 year lifetime by selling futures across this period. The only anomaly is the higher backwardation in the front month, which suggests some speculator is buying bull spreads on the front 2 months in large quantities (OR as Eyez suggests, some temporary anomaly due to market makers rebalancing their portfolio). The Brent Crude has gone into Contango in the front few month due to the recent/ongoing unwinding of a huge short hedge position of around 300,000 contracts (see thread about CL below 90) : this huge short hedge was artifically keeping Brent Crude front months in backwardation for the last few years. Unless Fracking picks up in Europe or some other huge short hedging need develops, Brent Crude should stay in Contango in the front months (transitioning to backwardation in back months) from now on.
Energy trader, thanks for the article. Very informative.... Couple of questions, if backwardation is normal, then the recent contango was abnormal then? Was there any clear cause for this? I had an idea (possibly misinformed) that a 'normal' curve(at least over the past few years) was contango at the front and then moving to Backwardation further on. So a steady backwardated curve from start to finish is 'the new norm' due to the extra cost involved in fracking?
mninjapan : You are right, normally the front month should be in contango. It actually is in cantango even now if you include the spot price, but normally the front month should each month transition from backwardation to contango to the 2nd month. There is definitely an anomaly in the front 2 months, but it seems to have been fading since it showed up. Perhaps it will eventually go back back into contango. The front month contango is traditionally caused by pension funds and Oil index funds that are always long the front month as part of an indexing strategy and keep the front month above spot. After they roll (5th to 9th trading day of the month) the front month should also go into contango relative to the 2nd month. Normally speculators will spread the front month contango across 2-3 months. This is also normally the source of front month contango in Brent, though the contango extending 6 months is an anomaly, perhaps due to the short position unwinding. However lately for CL the hedging needs of US fracking companies has completely overwhelmed the speculators and may now even have overwhelmed the pension funds and Oil index funds, which would put all months into backwardation. In that case however the front month backwardation would NOT exceed the other months, since it would then be cheaper for US fracking companies to hedge using the back months than the front month, eventually equalizing the front month backwardation. Therefore I can't explain the front month backwardation being steeper than the next few months in CL.
Very informative and insightful. Thank You. May I know how I can increase my knowledge in this regard?
Energy TRader: Again, very informative, thank you. These front spreads don't seem to want to stop....... Short term supply issues(random guess.....)???
I'm having a hard time trying to find reason with the front end of this curve..... A few weeks ago I came to the conclusion the situation in Cushing played a large role and that with the 2 new pipelines into Cushing we would see a reversal in the net outflow from Cushing (or at least a flattening of) and once all Cushing supply fears were allayed the front end of the curve would flatten out somewhat. But here we are, seeing a slight increase in Cushing stocks over the past few weeks, and getting closer to the pipelines coming online yet the curve is continuing on its merry way..... I still haven't lost all hope of my thesis playing out, that the market won't be happy till everything is up and running and stocks are again plentiful in Cushing, but I have this growing feeling that I am missing something here ( probably staring me right in the face too.....) Anyone care to step in with their thoughts (or enlighten me on the obvious)?
Yes. Market is bearish. Back months more so. Which is why the spreads are up. People expect a prolonged phase down.
I am surprised no one pointed out that since CL is priced in USD, its price has a lot to do with the USD strength, so this most recent decline in CL can be explained to a large degree with the USD strength. Take a look at the chart below where the CL is superimposed on the EUR-USD. There is a very pronounced correlation, especially starting from June 24, when CL has peaked.