Lower oil stocks here to stay? - IEA

A backward market, where spot prices are higher than forward contracts, occurs when there is a shortage of spare crude. End users needing to buy crude for immediate use pay higher prices and forward prices are lower on the expectation of improvement in supplies and that demand may be affected by the high spot prices.

In a normal or oversupplied market a contango structure usually develops where forward prices are higher than spot prices. If end users feel their stocks are adequate then nearby prices will have to fall to encourage more buying. Forward prices would have to be higher or end users would buy forward rather than add to existing stocks. There is, however, a limit to the forward premium which is when the cost of holding crude from one month to the next (finance, storage, insurance) is equal to the price difference between the two months.

Looking at NYMEX WTI futures month 1 - month 2 spreads and US-50 industry stocks in the period January 1995 to January 2003, the spread moves into contango when stocks are high and backwardation when stocks are low. However, since 1999/2000 the backwardation appears to have adjusted much more rapidly to any sign of improvement in stocks and in 2002 it appeared as if the market was moving into contango at a much lower stock level than in the mid 1990s, indicating that primary consumers may have changed their buying patterns. IEA note that there is not enough data to prove this point and that factors such as OPEC pronouncements, political disturbances and seasonality can all affect the level stocks that the industry is happy to hold.

Contact: Erik Ranheim