Crude Oil Market Tightens
Jul 21, 2023
WTI crude oil futures (/CL) are set to close out their fourth weekly gain after rising over 1% to $76.69 per barrel on Friday, through mid-day trading. Signs of a tighter oil market are flagging a signal to energy bulls. Friday’s move sets up prices to challenge levels not traded at since April, while July is on track for the largest monthly percentage gain since October.
Several factors are underpinning the strength in oil markets. First, the Organization of the Petroleum Exporting Countries (OPEC) and its ally Russia have initiated a series of production cuts. Speaking of OPEC’s eastward ally, Moscow has recently injected new geopolitical uncertainty into commodity markets surrounding the grain deal, indirectly benefiting oil prices by increasing headline risk.
The production cuts have likely encouraged traders to refrain from purchasing downside protection on oil positions. This belief stems from the expectation that OPEC will not tolerate a sustained drop in prices. As a result, oil volatility, as measured by the Chicago Board Options Exchange’s Crude Oil Volatility Index, has fallen to multi-year lows this month.
Simultaneously, contract volumes of crude oil have reached their highest point since March. These data points suggest that many traders hold a bullish view on the market. Last week, the Commodity Futures Trading Commission (CFTC) Commitments of Traders reported a 21,770 increase in long contracts among money managers for the week ending July 11. An update on this data is expected this afternoon.
Now, the oil futures market is indicating a potential increase in prices. The time spread between the front-month WTI contract and the follow-on month experienced a surge on Friday, reaching its highest level since November at 0.33 after surpassing the April high mark.
The expansion of the time spread typically suggests a perceived supply/demand imbalance in the market. In this case, it is driven by front-month prices increasing at a faster rate than the next month's price. This indicates a higher demand for oil in the present compared to the future. The correlation between the spread and underlying oil prices is depicted in the chart below.
Earlier this month, the U.S. Energy Information Administration released its short-term energy outlook, which forecasted higher prices starting this month through the end of the year due to higher petroleum consumption and modest inventory drawdowns.
That said, oil inventories have started to decline. For the week ending July 14, U.S. crude stocks fell by 2.9 million barrels at the Cushing storage hub, and gasoline stocks declined by 1.06 million barrels. Headline risk and inventory data will likely drive oil prices over the coming weeks, but the price bias, for now, is angled upward.
Thomas Westwater, a tastylive financial writer and analyst, has eight years of markets and trading experience. @fxwestwater
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