We’ve mentioned the oil futures curve several times since it fell into steep backwardation around the time of Russia’s invasion in late February of this year. Most recently, in Oil Market Showdown (October 11, 2022), we noted the flattening of the curve in recent months. Now, the easing of near-term price pressures flipped the futures curve to contango over the next six months. This is a signal worth noting, especially given how rapidly near-term prices dropped. 
Contango is the more common state of most commodities futures curves, including oil. The steep backwardation we have experienced recently for oil indicated the high desirability of holding physical oil now versus contracting for delivery later. This flip in the near-term curve indicates a significant drop in desirability of physical oil, indicating supply is outstripping demand.
Our impression at this point is that recession fears are driving the pullback. As noted in the October 11th piece, there are long-term structural issues with the energy sector and some short-term state actions (such as the EU embargo and the G7 price cap, both of which went into effect on December 5th) whose impacts are yet unknown. However, the rising risk of recession in the US and stagnant growth in other major economies are the main story, and we expect this to be a continuing theme.
The curve is bending six months out, around the June 2023 contract. This may indicate a seasonal component will play a role and markets will get tighter again in the summer months. By this time, we should also have a much clearer picture on the outlook for the US economy. It’s also worth noting the entire curve has flattened significantly. Futures prices six month out, the present peak, are still much lower than they were just a week ago.
As we noted in Wait for it… Wait for it... (December 6, 2022), it’s still unclear where the economy is headed from here, and we may not know for some time yet. However, the flip in the futures curve indicates a material loosening in a market that was incredibly tight just a few months ago. Participants (hedgers/investors/traders) seem to believe demand will stay relatively subdued in the near-term, which may be interpreted as a bet against the soft landing.
Important Disclosures & Definitions
Backwardation: when the futures price of an underlying asset is lower than the spot price/current price.
Contango: when the futures price of an underlying asset is higher than the spot price/current price.
West Texas Intermediate (WTI) Crude Oil: a specific grade of crude oil and one of the main three benchmarks in oil pricing. WTI Crude Oil is the active forward futures contract under ticker “CLA Comdty,” quoted at USD per barrel.
Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.
One may not invest directly in an index.
AAI000189 03/31/2024
