Backwardation "vortex" fueling oil's rally

NEW YORK (Reuters) - Falling crude inventories and the shape of the futures curve will likely continue to feed back into each other and boost oil prices further until there is a meaningful change in the global supply picture.

Since July the market has been "backwardated," where the price of oil that is about to be delivered is higher than for later deliveries. Backwardation encourages the sell-off of stocks and is seen as a sign of supply tightness or even shortages, which further boosts prompt prices.

The current rally will likely go on until oil supplies rise or demand falls enough to reduce the incentive to sell off oil in storage, energy experts said on Wednesday.

"Given the economics of storing oil, it makes no sense to hold on to inventory right now. Storage owners are taking the economically prudent step and dumping inventories," said Stephen Schork, editor of the Schork Report.

U.S. crude futures for delivery in December hit a record of $94.74 a barrel on Wednesday and were running more than a dollar higher than those for delivery in January and more than $5 higher than those for delivery in May.

"We're in a hamster wheel right now," Schork said. "This can only end when there is not enough prompt demand to sop up supply on the spot market."

U.S. commercial crude oil inventories fell nearly 4 million barrels last week, spurring another rally in crude prices which hit a record above $94 a barrel. Much of the drop came at the delivery point for the New York Mercantile Exchange's (NYMEX) crude oil futures contract at Cushing, Oklahoma.

"Backwardation in the NYMEX futures curve remains steep, and today's eye-catching decline in crude stocks held at Cushing will help to entrench the current curve structure in the near term," said Harry Tchilinguirian of BNP Paribas.

SUMMER STOCK SLIDE

U.S. crude oil inventories have tumbled by 41.4 million barrels or 11.7 percent over the four months since the end of June, according to U.S. government data.

The drop has been even more pronounced at Cushing where stocks have plunged by 36.5 percent to 15.05 million barrels.

A lot of the majors are cutting their imports into the Midcontinent and are running down stocks held at Cushing and other inland storage points," said a U.S. crude oil broker.

Shipments of crude oil up the 350,000 bpd Seaway pipeline, which brings imported crude from the U.S. Gulf Coast to Cushing, slumped to 104,000 barrels per day in the third quarter compared with 239,000 bpd a year ago, according to TEPPCO Partners LP, which holds a 40 percent stake in Seaway.

Energy experts said oil's 35 percent rally since August is due largely to slipping inventories in big consumer nations amid OPEC's reluctance to hike output.

"I wouldn't attribute oil's current rally all to backwardation. This is strong market on a fundamental basis which has caught the attention of speculators," said Sarah Emerson, director of Energy Security Analysis Inc in Boston. "But the backwardation reinforces the move up in price."

"The thing about backwardation is if you have a rally in the prompt contract, you get into the backwardation vortex. It is a self-reinforcing cycle," she said.

OPEC producers agreed to hike output 500,000 barrels per day starting in November, but many oil analysts have said the move is not enough to ease the tight market.

OPEC ministers are expected to discuss the supply situation at an informal meeting in Saudi Arabia in November.

(Additional reporting by Janet McBride in London)