Back of oil curve rises on recovery expectations

By Rebekah Kebede and Robert Campbell - Analysis

NEW YORK/MEXICO CITY (Reuters) - While slumping demand has sent front-month oil futures tumbling, expectations that supply and demand fundamentals will tighten again with an economic recovery are propping up the far end of the futures curve.

Front-month oil prices have dropped 50 percent to around $72 from a record high over $147 a barrel, while December 2016 crude has dropped from $140 to $85 over the same period.

The sharper fall in front month crude has pushed the oil futures curve into contango -- a structure where front month crude trades at a discount to later months -- typically a sign of a well-supplied market and weak demand.

"We've got kind of a normal curve ... probably more normal than it has been in a while. To me it suggests that we're going to see the economy rebound and come back, but it's not going to happen overnight," said Phil Flynn of Alaron Trading in Chicago.

The spiraling credit crisis has dimmed the outlook of even bullish oil analysts, with Goldman Sachs slashing its forecast 2009 oil price forecast to $86 from $127 a barrel this week.

But longer-dated futures would range between $95 and $105 a barrel, Goldman Sachs said, reflecting the continued high cost of adding new oil production capacity.

"The longer these financial problems continue ... the longer it will take for economic momentum to resume, oil operations to normalize and (short-term) downward oil price pressure to reverse," a Goldman research note said.

The shape of the curve also implies investors are betting on some demand recovery toward the end of 2009 -- where December 2009 crude is trading at a $7 premium to the front month November crude, some analysts said.

"(The shape of the curve) suggests that we do have an amply supplied market and suggests that underlying demand is weak," said Jim Ritterbusch, president of Ritterbusch & Associates in Galena, Illinois.

Weak consumption could drive oversupply up to 2 million barrels per day or more next year unless there is a severe price disruption or OPEC trims output, some experts said.

INVESTOR FLIGHT

Reflecting investor flight to safer havens, open interest contracts for New York Mercantile Exchange crude oil futures have fallen from 1.36 million contracts in mid-July when oil reached a record, to two-year lows last week, according to the Commodity Futures Trading Commission. [nN07454240]

But investors have increased exposure to some long-dated contracts in 2012 and 2013, where open interest is now higher than it was at the market peak in July.

Open interest contracts for December 2013 have increased by about 30 percent, while contracts for December 2012 have increased by about 15 percent.

Some investors have seen this dip in oil prices as an opportunity, analysts say.