NEW YORK (Reuters) - Long-term U.S. crude oil markets flipped into contango this week for the first time in years, as the dizzying descent in prices unleashed a wave of hedging by oil producers fearing prices may not stay above $80 a barrel for long.
Contango, in which longer-dated futures are more expensive than near-term contracts, has yet to take hold at the prompt end of the oil futures curve, from the front month, November 2014, well into 2015.
If that changes, it could accelerate selling of the front months by investors who would face added losses from rolling forward positions, traders said.
The 2016 calendar strip WTI swap contract fell to below $80 a barrel on Wednesday for the first time since the start of the year. Trading volume in Dec 2016 oil futures spiked to over 16,000 lots on Tuesday, double its recent average, and then surged again to over 34,000 lots on Wednesday.
The 2016 contract, which barely fell $4 from June to late September even as prompt prices slid, has now plunged $9 in about three weeks. The 2015 year swap has fallen even further, dropping more than $10 since Sept. 26.
On a continuation contract basis, the first-year contract is trading below the second-year swap for the first time since late 2012. The contango reached more than $1 on Tuesday, the steepest such structure since 2011, data show.
“There’s been a lot of movement or volatility on the curve structures,” said John Saucer at Mobius Risk Group in Houston, which handles hedging for producers and consumers. “The curve is making its move into contango, and other than the first couple of months, we’re in contango. It’s not just flirting with contango, it’s not just flat, it’s established.”
European Brent crude oil has been in contango for several months. But in the U.S. market, oil futures through most of 2015 remained in backwardation due to relatively stronger U.S. market fundamentals and lower inventories.
Even as prices crested this summer, long-term prices have been lower, discouraging producers from hedging, Saucer said.
That changed abruptly over the past few weeks amid growing signs that OPEC’s most influential members are in no hurry to prop up prices. Many traders and producers who had been counting on Saudi Arabia to maintain oil prices at around $100 a barrel are now reassessing, and hedging against further losses.
As prices have fallen, producers have been working to secure hedges for the next 12 to 24 months, Saucer said. “You want to get your hedges on where you’re most vulnerable.”
Options trading has also surged as producers buy options to guard against lower prices. The CBOE’s oil volatility index has surged to its highest since 2012.
The pressure has been most intense on the 2016 contracts, some brokers said, as much of next year’s hedging business is already concluded and drillers are reluctant to lock in 2017.
“For 2017 you’ve got time, you might not have to sell, but if bankers are putting pressure on to do it then you do,” said Andy Lebow, Jefferies Bache LLC Senior Vice President.
Nearer-term months may shift toward contango by the end of the year, some traders said, anticipating that weakness in global markets will eventually swell U.S. inventories too.
That could lead to broader liquidation from index investors, who roll positions forward each month. In a backwardated market they can sell the costlier contract and buy a cheaper contract, yielding a positive roll return. But that would become negative if contango takes hold.
“Contango is starting to show itself. The March-April spread is only backwardated by 24 cents,” said Tariq Zahir of Tyche Capital in New York. “We think in a month or a month and a half, it should shift toward a contango. It may happen rather violently.”
Reporting By Jessica Resnick-Ault