The West Texas Intermediate crude market has moved into a solid contango, with the August contract trading at a premium to the July contract. This sort of market structure is necessary to build inventories. The opposite structure, a backwardation, features prices in the "out" months declining from the front month, which is an incentive to sell inventories into the market. A contango encourages building inventories.
With crude inventories in the US declining week-by-week (four weeks in a row), and the International Energy Agency recently reporting global crude inventories declined in April, a month where they traditionally rise, the emergence of the contango in the WTI market could be a sign that inventory destocking will turn around into an inventory build. Such a build is necessary in the second quarter to prepare for the 4th quarter inventory draw.
But not so fast. The current contango between July and August is roughly 60 cts. In a recent story written by Sheela Tobben and Esa Ramasamy, Platts reported that the capital cost of trading physical crude is now almost double what it was a year ago. Speaking to traders, the reporters were told that the cost of holding the crude, effectively the interest paid for the funds borrowed to hold the crude, is now estimated at about 60-70 cents/b, and storage costs are now estimated at around 60 cents/b.
That means a spread of $1.20/b is required to be an incentive to store crude. That's double what is in the market today. One trader said the cost of holding crude has increased "by a factor of two...at least 1.5" over the past year.
Blame it on the credit crunch. "It has become harder to trade since you don't have that much credit any more," one trader said. "Your credit is half what it was when crude was at $70. This means you can't trade as much since you need that credit to sell your physical oil."
"The contango has to be at least $1.20/b before anyone would dare to take up a position," one trader said. "I have never seen WTI's contango between the front and second month anywhere near $1.20/b."
Actually, the NYMEX front-to-back reached $1.47/b back in 1998, when the world was groaning under a tremendous glut. Remember too that the $1.47 spread came against a front month price of $11.56. That was a truly astounding spread, given the flat price.
Sheela and Esa reported that refiners, because of the combination of credit constraints and the high flat price, are putting off buying until the last minute because of the unfavorable flat price. And because they have put off buying for as long as possible, they have run down their stocks to these low levels. US refiners are buying only on a need-to basis, and the high flat price is overshadowing any benefits that a contango, even wider than this one, might provide for buying oil now and storing it for later.
For those watching that front-to-back, and getting encouragement that stock building may be getting closer, the fact is you may need to wait for a long time.
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