Oil Futures Signal Higher Inventories, Lower Prices for Crude
2005-05-05 10:13 (New York)
By Mark Shenk
May 5 (Bloomberg) -- Gene Edwards, head of oil supply and
trading at Valero Energy Corp., the third-largest U.S. refiner,
has 1 million to 2 million extra barrels of oil in his company's
storage tanks.
Edwards is among the refiners, brokers and traders adding
oil to inventories because spot prices are cheaper than futures
for crude delivered later in the year, a price difference traders
call ``contango.' Contango ``tells us to buy a little extra,'
Edwards said in an April 19 interview.
At today's prices, the money saved buying oil for June
instead of July more than pays the cost of storing it,
encouraging buyers such as Edwards to hold more. The contango, at
its widest since at least 1998, is also a sign to some investors
that crude prices are poised to fall further.
``This is a seriously bearish indicator,' said Michael
Lynch, president of Strategic Energy and Economic Research, a
Winchester, Massachusetts, consultant. ``The contango reflects
concern about supply later this year, but the rise in inventories
can't be ignored forever.'
Federal Reserve Chairman Alan Greenspan cited contango in an
April 5 speech, saying that it ``could encourage enough of an
inventory buffer to damp the current price frenzy,' which the
day before had pushed oil to a record $58.28 a barrel on the New
York Mercantile Exchange.
Oil prices are off 14 percent from the April 4 peak. The
June futures contract, known as the ``front-month' because it is
closest to delivery, rose 32 cents to $50.45 at 10:07 a.m. in New
York. June was $1.75 cheaper than July and $3.40 cheaper than oil
for December.
Oil prices dropped in April as U.S. crude oil inventories
climbed to the highest in almost six years. Supplies in storage
are up 13 percent so far this year, to 327 million barrels as of
April 29, according to Energy Department data.
Contango, Backwardation
The contango in the oil market developed over the past five
months. For most of last year, the front month was more expensive
than later delivery dates -- a price relationship called
``backwardation.' Oil was in backwardation 80 percent of the
time over the past three years, based on New York futures prices
for the front and second months.
Contango, from the word ``continue,' and backwardation are
terms that came into use in the English stock market in the 19th
century. The Oxford English Dictionary cites a magazine from 1860
as the source of the saying, ``The Bear a good contango loves,
the Bull a backwardation.'
The other periods of contango in New York oil futures over
the past decade occurred after the Sept. 11 terrorist attacks in
2001 and during the Asian financial crisis in 1998, when prices
were sliding to a 12-year low near $10 a barrel. These were times
when unexpected interruptions of demand cut prices.
`Unprecedented'
``When futures were in contango in 1998, the market was in
the absolute doldrums,' said Rick Mueller, an analyst with
Energy Security Analysis Inc. in Wakefield, Massachusetts.
After Sept. 11, buyers assumed demand would rebound, and
they priced oil for delivery in future months and years
accordingly, wrote Deutsche Bank analysts Paul Sankey and Adam
Sieminski. As the front month dropped below $18 a barrel, buyers
remained willing to pay as much as $24 for later months, they
said in a May 1 note to clients.
Today's contango, during a time of high prices, is ``totally
unprecedented,' Sankey and Sieminski wrote. Because a contango
like this hasn't happened before, both a bearish and a bullish
interpretation should be considered, they said.
`Overflowing'
The oil market ``may even collapse, as storage is
overflowing,' they wrote. Alternatively, demand will pick up as
drivers hit the road for vacations this summer and boost gasoline
demand, providing ``yet more proof' that global output can't
keep pace with demand. That could push New York prices to $60,
they said.
The market contango ``perfectly reflects the market
sentiment,' said John Kilduff, senior vice president of energy
risk management with Fimat USA Inc. in New York. ``There is a
tremendous fear that fourth-quarter demand will outpace supply.
In the meantime we are sitting on multiyear high inventories. It
pays to stockpile before the impending shortfall.'
If that view is correct, refiners such as Valero will look
smart for having filled their storage tanks.
``Basically it costs 35-to-40 cents a month to store oil,'
said Ed Silliere, vice president of risk management at Energy
Merchant Intermarket Futures LLC in New York. Finance charges may
bring that to 50 cents a barrel per month.
By comparison, the contango between the front-month contract
and the second month has been more than $1 for almost five weeks.
When spreads are as large as they have been in the past month,
``you are going to do storage,' Silliere said. |
