Categories: General Market Commentary
Topics: General Market Commentary

Next oil rally? Futures say market Is tightening

Next oil rally? Futures say market Is tightening

U.S. oil inventories are at record levels, but there are a few glimmers of hope that the glut could be starting to subside.

Storing crude oil for sale at a later date is no longer profitable, as the futures curve has flattened out in recent weeks, depriving traders of a strategy that has served them well over the past few years. The market “contango,” in which front-month oil contracts trade at a discount to oil futures six months or a year out, has all but vanished. The differential must be large enough to cover the cost of storage, and for many time spreads that is no longer the case. After three years of a steep contango, storing oil simply to take advantage of the time spreads is increasingly uneconomical.

One of the more expensive forms of storage is floating on tankers at sea, and because of the narrowing contango, floating storage is unprofitable today. Reuters reports that traders are beginning to unload crude from floating storage along the Gulf Coast. "Right now, traders aren't incentivized (to store)," Sandy Fielden, director of oil and products research at Morningstar, told Reuters in an interview. "It won't all stampede out of the gate, but inventory levels will come down. What will happen is that some of it will go to refineries, but a fair amount will be exported too."

Just as the rapid rise of floating storage in 2015 and 2016 was a sign of the deepening global supply imbalance, draining tankers of stored oil is an early sign that the supply glut is receding.

So far, it is only the most expensive storage facilities that are seeing drawdowns – the U.S. on the whole has seen crude stocks swell to record highs. But oil analysts argue that the surge in crude inventories is a symptom of stepped up imports booked at the end of 2016, when OPEC members pumped out huge volumes of crude just ahead of implementation of their deal to cut production.

After a few weeks of transit time, the extra supply started showing up in U.S. storage data in January and February. In other words, the stock builds could be a temporary anomaly.

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