(Bloomberg) — The structure of the U.S. crude oil market signaled oversupply for the first time in nearly a year, the latest indicator of the scale of the dramatic decline in the near-term oil futures market.
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The forward-month spread, which reflects the short-term balances between supply and demand, is trading in contango – the industry term for the bearish market structure – before the December contract expires on Monday. Another subsequent spread also turned to contango. The rest remain in the opposite bullish structure known as a pullback, indicating that the move may still be short-term.
Much of the move can be attributed to futures traders piling up a bloated long position and heading for the exits at the same time as underlying prices tumble on worries about demand, market participants said. Underlying weakness in the physical market and near-term factors such as a Texas pipeline outage and high freight rates also caused time spreads to collapse as West Texas Intermediate futures fell below $80 for the first time since September.
Friday’s crash also coincided with the expiration of options contracts on the December-January spread. There are almost 13 million barrels of put options that would gain if the spread were to expire in contango. When options pass through the levels at which they pay off, they can stimulate additional sales.
“At the end of the day, demand for oil from Asia is not good, and while it may be decent in the U.S., they are struggling with pipeline disruptions that are slowing exports and generating weakness that could last several weeks,” said Scott Shelton, energy specialist at TP ICAP Group AD. “The market positioning was the exact opposite, which forced liquidation and made this even worse.”
Contango can make it more profitable for traders with access to storage to put oil in tanks and sell at a later date, depending on the extent of the price difference. If the oil markets are in contango for an extended period of time, this also generates what is known as negative yield, where investors tend to lose money when they roll a position forward from one month to the next.
Weakness in U.S. light crude oil prices has played out in physical markets in recent days. Crude at Magellan Midstream Partners LP’s East Houston terminal traded at its weakest level since May, according to Bloomberg Fair Value data. Permian oil was also at a near six-month low, the data showed, as a vital regional oil pipeline operated by Shell Plc operated at a reduced pace.
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