Hello everyone,
As you may have seen in the daily thread, I am very interested in oil right now. I thought I would write a quick post to discuss oil futures and share my ideas. For this post I'll be bringing up the first 6 oil futures contracts, from USOIL to CLGH027 (Mar2027).
As many of you know, we are in backwardation, a barrel of oil today costs more than oil in the future. This happens when there's an immediate disruption. Like the one we've experienced in the Strait of Hormuz, a strait that has been closed for a very long time. I don't personally see the supply. What I do see is a world burning it's reserves as fast as they possibly can in refiners running at full capacity. Diesel is soaring.
The SPR is down to 293.4 Million barrels of oil. That sounds like a lot. Except in reality they need congressional approval in order to draw below national defense limits.
credit to u\/MarmotFullofWoe for the plot
Since the MOU went up in flames the SPR draws have started to creep back up in size. This week we were back to drawing 5.2 million barrels and the week before 6 million barrels. This is probably because the situation in the strait has remerged. That means we have 8-12 weeks before the SPR hits the floor.
That said, lets look at what the market actually thinks might happen. We are in backwardation right now. That's undeniable. What I want to suggest, and what I believe, is that the curve is going to uninvert or it is all going to rise. If the entire futures curve is rising that means there's a bullish market in the thing itself, oil, as a thing in the world is going up in price far into the future.
When I look at these contracts, I see higher and higher prices. I see contracts that are rapidly approaching their "peak war" time levels. One of which has actually surprised the front end price.
Basically, the market is coming around to the idea that the current supply picture is going to continue into the future, or get worse.
I say it could possibly get worse because if you look at the oil futures contracts, the deferred barrels, barrels in the future, are rising faster than the upfront prices.
There's an open question of momentum, does the back end of the curve continue to outpace and cause it to invert, or are we approaching a great flattening? Additionally, October barrels are being priced higher than the ones today. There's already one contract that's not backwardation.
What I am worried about, and why I have a position in oil, is that we could be moving into the following curve (numbers modified by hand as a suggestion of shape--not real value)
If this mess was getting resolved, you would see a front end collapse in prices. The market would say that the situation itself was becoming resolved. That situation would look like:
Front End Collapse - The Issue resolved and supply is restored
In my opinion this is the anatomy of an oil shock and a potential crisis. It isn't the immediate backwardation that creates a problem, it's the structural repricing. It's the change in the futures curve of oil. If we were getting out of this, the front end contracts would crater and the back end just would start to flatten out (not saying long term, but that's what the moment would look like imo).
The problem is that the front end isn't collapsing. The back end is rallying.
Psychologically, a real oil shock (not a one time event) occurs in stages:
- Shock (exiting here)