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The Crude Oil Futures Market Structure

Source: OPEC 11/25/2013, Location: Europe

The backwardation between the ICE Brent crude futures first- and second-month contract has eased significantly over the month, moving toward contango at the end of October where the cost of immediate supply is cheaper than in the future for the first time since June, reflecting easing concern about supplies and weak refinery demand. The price spread between first- and second-month Brent contracts narrowed to 60 on average in October from $1.20 in September. The main reasons for the move towards contango are the higher output of North Sea crudes and a lack of crude demand due to poor refining margins. This increase in supply comes against a background of ongoing weaker demand for crude oil, as refiners have yet to emerge from turnarounds on both sides of the Atlantic. The move towards contango also illustrated that Brent's fundamentals were under pressure given recovering global supplies. Iraqi exports rose in October after building work at southern terminals and seasonally lower domestic demand in the Middle Eastern Gulf freed up more crude for export. November's output of the four BFOE North Sea crudes is expected to reach a high for 2013.

In the US, the Nymex WTI flipped into contango mid-month onward as higher refinery maintenance, estimated at 1.3 mb/d, ate into demand, causing a steady stock-build at Cushing, Oklahoma, the delivery point for US benchmark futures. Amounts at Cushing rose by more than 2 mb, the largest build since December 2012, in the week ending 25 October. Healthy stockpiles of crude, including significant stocks of oil on the US Gulf Coast, the nations' refining center, have also pressured prompt requirements for crude. Meanwhile, the contango structure provided more incentives to store crude at a time when inventories are already elevated in some areas. On average, the first month versus the second month time spread flattened to almost zero compared with around 50/b in the previous month.

The transatlantic spread widened significantly to levels seen earlier in the year, nearly reaching $9. While Brent continues to find some support in geopolitical factors, the weakness in the Brent-WTI spread can be attributed more to WTI, which has come under strong pressure from several factors, key among them being refinery maintenance in the US. While the spread has expanded recently to $8.89/b from $5.02/b, it is expected to narrow as US refineries emerge from maintenance season, which has slowed domestic demand for crude. Meanwhile, the widening spread will encourage refiners to return to production and eventually narrow the spread.

Moreover, the recent crude price collapse is not specific to WTI, but is rather an illustration of weakness across the entire US crude complex. For instance, US Gulf Coast grades Mars and LLS have recently seen their differentials to Brent increase to record highs amid limited appetite for crude along the US Gulf Coast at the moment, given ample inventories in the region. The Brent-LLS spread moved to $6.20/b in October from $3.75/b in the previous month, while the Brent-Mars spread rose to $11.30/b from $8.25/b.

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