Walking Down Spreads the Line

Dr. Ken Rietz

March 14, 2024

This is the fifth monthly commodity futures spreads commentary. In the past four issues, I have introduced the four main categories of those spreads: product, intermarket, calendar, and ratio. My plan for the next commentaries is to dive a bit deeper into those spreads, while still presenting the crack spread each time, since that seems to be the most important to you. This month I am going to look at calendar spreads again, because it illustrates a feature that is worth looking at. But first, here is the crack spread. The graph generally expresses how profitable refinery operations are likely to be.

Figure 1: The crack spread for May 2024 WTI crude oil, in USD per barrel

To remind you, a calendar spread happens when you sell a futures contract at one month and simultaneously buy a futures contract on the same commodity at a different month. Typically, you sell a near-term contract and buy a far-term contract (near and far being relative). Since the values of futures contracts change over time, the opportunity for making money exists.

We focus this month on NYMEX WTI crude, and the essential information is the price of the futures contracts. The graph of the prices of the monthly contracts is called the forward curve, available on the Fundamental Analytics platform.

Figure 2: The forward curve for NYMEX WTI crude

The typical shape of the forward curve is to go up for the first few months, and then drop. That means that the cost of futures contracts increases (called contango) and then drops (called backwardation). But this curve drops from the beginning. This does happen, of course, but it is not common. The last major backwardation was September 2023, right after crude oil was approaching $100 per barrel. It is also possible that the crude oil market goes into contango, which was the situation during the 2020 pandemic.

Backwardation is typically associated with bearish markets, when prices look to decrease. And conversely, contango is associated with bullish markets, when prices look to increase. But be careful to realize that a futures contract price is at best an estimation of a spot price in the future; it is not a guarantee.

Of greater interest is the reason for the backwardation in crude oil right now. (It should be noted that ICE Brent crude oil is also in backwardation.) There are numerous potential reasons. The market may expect that the US will continue to produce larger amounts of crude oil. Or they may expect that OPEC+ will slow down their reductions in oil output. Or they may see that China will slow down their imports. Anything that reduces demand or increases supply can contribute to backwardation. But a reasonable expectation is that the price of crude oil decrease in the near term. Opposing this position, the forward curve displayed above (as of end-of-day March 13) might not have sufficiently processed the just released IEA data indicating an increased overall demand (though the increased demand percentage is getting smaller) for crude oil.