Solid backwardation on WTI

The chart above displays the price differential between CME front-month WTI and the contract six months out. There are two key takeaways: firstly, the graph clearly shows the volatile nature of the crude oil market in 2023; strengthening of the structure of the oil benchmark can be followed by an outsized weakness on the front-end, considerably reducing the premium the first month commands as market players react to headlines both in the oil and financial markets. Secondly, it is noticeable that apart from a brief dip into contango at the beginning of the year, where oil for immediate delivery is cheaper than further down the curve, the structure of the crude oil marker has reliably been backwardation – despite the occasional sell-off.

This resilience, it appears, has firm legs to stand on and is fundamentally justified. To begin with, fuel demand has the potential to grow in the latter part of the year as inflation seems to be under control and macro data points to rising economic activity. Indeed, the Energy Information Agency expects U.S. gasoline demand to return to growth on an annual basis in 2023. Support will also be forthcoming from refiners. As the turnaround season ends and the driving season kicks in, utilization rates are expected to pick up. The depletion of U.S. crude oil inventories should get under way helping the structure strengthen, which, in itself, is a self-fulfilling prophecy: the deeper the backwardation the more incentivized refiners are to draw down inventories as opposed to purchasing crude oil from the open market. Sluggish domestic production growth and unquenchable thirst for U.S. crude from overseas are also seen as constructive factors. And finally, one must take into account the impact of financial market participants. Sluggish domestic production growth and unquenchable thirst for U.S. crude from overseas are also seen as constructive factors. And finally, one must take into account the impact of financial market participants. Against this backdrop, additional structural gains in the crude oil benchmark with occasional, but brief downside corrections, may be anticipated.

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