In a balanced market, the crude oil structure is in contango. In this case, supply is perfectly aligned with demand, and inventories are adequate to cover any plausible supply disruption. In this hypothetical equilibrium, the extent of the monthly contango is precisely the cost of carrying one stored barrel of oil from one month to the next. It includes the following factors: storage fees, insurance and financing costs (i.e., interest rates). Of course, this equilibrium hardly ever materializes. At times of oversupply, inventories are bulging and the contango is wider than the cost of carry. During disruptions and conflicts around oil-producing regions, stocks are depleted and the fear of being unable to secure sufficient supply flips the crude oil structure into backwardation.

It is the latter that the oil market has had to contend with, precipitated by the double whammy of the war in Ukraine and the Persian Gulf crisis. As the race for available barrels intensified, global and regional oil inventories declined, putting profound upward price pressure on physical barrels and shorter-dated contracts, which, in turn, widened backwardation. One way to take advantage of the situation is to lock in this backwardation by selling physical oil from storage and replacing it with cheaper barrels further down the curve. In the current uncertain environment, however, this strategy would further deplete inventories and boost the premium that the front end of the curve commands over longer-dated contracts.

So, when could the current market structure reverse? The relationship between the crude oil curve, inventories and interest rates is not direct and is very loose. Yet, at times of geopolitical upheaval, they move in lockstep and mutually influence one another. Low stocks lead to elevated energy prices and steep backwardation, causing inflationary pressure, which forces central banks to raise borrowing costs, as reflected in the rising U.S. 2-year Treasury yields and the latest Fed decision. This makes the cost of carrying one barrel in storage from one month to the next more expensive and disincentivizes inventory replenishment.

The present relationship between interest rates and the WTI structure is a circular affair; currently, they are joined at the hip and are affecting each other. Once oil starts flowing permanently and reliably, inflationary pressure will ease, sowing the seeds for lower interest rates, which in turn, together with falling outright prices and a possible switch back to contango, would provide an incentive for stock builds. Until then, high interest rates will remain one of the salient factors seen as prohibitive to stock builds, supporting backwardation in WTI.