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Crude Oil Price Analysis for March 5, 2018

By:
David Becker
Published: Mar 2, 2018, 17:14 GMT+00:00

Crude oil prices are consolidating in the low $60’s, and despite daily volatility, which has been choppy of late, the term structure of the market says

Crude Oil

Crude oil prices are consolidating in the low $60’s, and despite daily volatility, which has been choppy of late, the term structure of the market says that prices should remain stable. The term structure can be a component that helps determine inventory levels, which will eventually help regulate U.S. production.

Technicals

Crude oil prices rebounded from session lows and were up on the day mid-day in North American trade.  Prices rebounded ahead of support near and upward sloping trend line near 59.80.  Resistance is seen near the 10-day moving average at 62.23. Momentum has turned negative as the MACD (moving average convergence divergence) index recently generated a crossover buy signal. This occurs as the MACD line (the 12-day moving average minus the 26-day moving average) crosses below the MACD signal line (the 9-day moving average of the MACD line).

What is the Term Structure of the Market?

WTI crude oil prices are physically delivered allowing commercials the ability to store crude oil in Cushing Oklahoma, or wherever its final destination might be.  Each futures contract represents a 1K barrels of WTI crude oil, delivered on a specific calendar date.  When prices for WTI today are more expensive than prices in the future, the term structure is said to be in backwardation. When prices in the future are greater than prices today, the term structure is referred to as in contango.

Why is the Term Structure Important?

When the term structure is in backwardation, and prices are higher today than in the future, it does not pay to store oil. In fact, prices could decline by the estimated amount generating a loss as the market slides over time to reach the current future price. Current the term structure of the crude oil market is in backwardation which is reflected in the chart of June 2019 minus June 2018.

As recent as September of 2017, the term structure of crude oil was in contango, and the steeper the contago the more lucrative it is to purchase spot oil and sell it forward.  A popular trading strategy is to store oil and sell it forward and lock in a profit, when the contango is steep. With the term structure of WTI crude oil in steep backwardation, there is a negative incentive to purchase oil unless you plan on refining it immediately. Based on current levels if you purchase WTI and the spot price declined over time to the future price, you would lose 8-10% depending on where in the $60’s the flat price of crude was reading. This means there is likely strong demand for spot crude oil, as refiners are profitable at current levels selling products.

It appears that the term structure is attempting to form a bottom.  If WTI prices declined into the low 50’s the term structure would likely revert to zero.  The current level is a clue about demand, which should keep petroleum inventories stable despite increased U.S. production.

 

Demand continues to remain strong

Demand continues to remain strong. The EIA revealed that total products demand over the last month averaged 20.4 million barrels per day, up by 2.7% from the same period last year. Over the month gasoline demand averaged 9.0 million barrels per day, up by 3.8% from the same period last year. Distillate fuel demand averaged over 4.0 million barrels per day over the last four weeks, up by 0.9% from the same period last year.

Imports Unexpectedly Increased

Imports unexpectedly increased in the latest week. U.S. crude oil imports averaged 7.3 million barrels per day last week, up by 261,000 barrels per day from the previous week. Over the last month, crude oil imports averaged about 7.5 million barrels per day, 8.1% less than the same month last year. Production in the United States increased, rising 13K week over week.  The current level of 10,283 is near a record high.

 

Inventories Where Mixed

The Department of Energy also reported that U.S. commercial crude oil inventories increased by 3.0 million barrels from the previous week. Expectations were for a smaller 2.5 million barrel increase. At 423.5 million barrels, U.S. crude oil inventories are in the lower half of the average range for this time of year. Gasoline inventories unexpectedly increased by 2.5 million barrels last week, compared to expectations that there would be a small draw. Distillate fuel inventories decreased by 1.0 million barrels last week. Total commercial petroleum inventories increased by 3.7 million barrels last week.

About the Author

David Becker focuses his attention on various consulting and portfolio management activities at Fortuity LLC, where he currently provides oversight for a multimillion-dollar portfolio consisting of commodities, debt, equities, real estate, and more.

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