Column: Backwardation beckons for WTI as US crude stocks fall

US crude stocks in Cushing may soon peak

By John Kemp

LONDON, Oct 24 – US crude prices appear set to follow the international Brent benchmark from contango into backwardation in the next few months as oil inventories in the United States dwindle.

US commercial crude stocks have fallen by 23 million barrels since the start of the year, compared with an increase of 19 million barrels at the same point in 2016, and an average seasonal rise of 24 million barrels in the last decade.

US light sweet crude (WTI) futures for the contract nearest to delivery closed at a discount of just 28 cents per barrel to the seventh-listed contract on Monday.

The front-month discount was the smallest since November 2014, when the oil market was only just entering its two-year slump.

Discounts for near-to-maturity futures contracts, known as contango, are a symptom of an oversupplied market with high inventories.

By contrast, premiums for nearby contracts, known as backwardation, are associated with an undersupplied market and low stocks.

Both Brent and WTI have been moving away from contango towards backwardation for more than two years as part of the market rebalancing process.

Brent futures first moved into backwardation in August and have been trading consistently in that condition since September.

But the price structure in WTI, which normally follows Brent, albeit loosely, temporarily disconnected in August and September.

WTI fell to a steep discount against Brent and remained stuck in contango, which deepened when Hurricane Harvey stopped many US refineries processing crude and left the country with a build up in crude stocks.

However, US crude exports have been running at record rates since the middle of September, according to data from the US Energy Information Administration (EIA).

With crude imports remaining sluggish, net crude imports have fallen to less than 6 million barrels per day from almost 8 million barrels per day in August.

At the same time, US refineries have been processing record seasonal volumes of crude to rebuild stocks of gasoline and especially diesel depleted by the hurricane and strong consumption at home and in export markets.

As a result, crude stocks along the East, West and Gulf Coasts have all fallen since the summer, are well below last year’s levels and appear tight.

CUSHING STOCKS

In contrast to the coasts, however, the Midwest has reported a continued build up in crude stocks, especially around Cushing, Oklahoma, the delivery point for the WTI futures contract.

Cushing stocks have increased in 10 out of the last 11 weeks, by a total of more than 8 million barrels, according to the EIA.

Meanwhile, in the rest of the country, crude stocks have fallen in eight out of the last 11 weeks, by a total of almost 36 million barrels.

Plentiful crude at Cushing has ensured WTI prices for maturing futures contracts have continued to trade at a discount.

But as refinery runs and exports empty coastal tank farms, the Midwest crude glut should gradually start to clear.

Cushing inventories rose by just 200,000 barrels in the week to Oct. 13, the smallest increase since the middle of August, and a possible sign that stocks in the region are peaking.

WTI calendar spreads have also strengthened, and now seem to be gradually reconnecting with Brent, another sign that Cushing inventories may be peaking.

WTI futures prices are still trading in a significant contango between December and February, but thereafter the contango becomes insignificant, and the market is in backwardation beyond April.

WTI appears to be following the same path beaten by Brent earlier this year towards a sustained backwardation in 2018.

(Editing by Edmund Blair)

John Kemp is a Reuters market analyst. The views expressed are his own.