(MENAFN- Gulf Times) The vanishing contango in US crude oil futures points to a sharp draw down in crude stocks over the next few months as the incentive to store excess oil disappears.
The price for storing US crude for six months has shrunk from around $8.75 per barrel in mid-March to $1.25 on Tuesday.
The price of storage barely covers the cost of financing the inventory and renting tank space so it will sharply diminish the incentive for buying and storing excess oil, known as the "cash and carry" trade.
The sharp narrowing of the contango is remarkable because reported crude stocks in commercial storage remain at the highest level for 80 years.
Crude stocks in the US have fallen in each of the last four weeks by a total of 11.5mn barrels, according to weekly data from the Energy Information Administration.
But crude stocks are still 94mn barrels (25%) higher than at the end of 2014 and 115mn barrels (32%) higher than the 10-year seasonal average.
Domestic oil production is expected to stabilise or even fall over the third quarter given the 60% reduction in the number of rigs drilling for oil.
But so far any slowdown lies in the future. Current statistics show crude production running at well over 9mn barrels per day, the highest since the 1972/73.
So why is the contango narrowing so much?
"Which came first, the contango or the build-up in stocks?" is a familiar causality question for oil traders and analysts pointing to the complicated two-way incentives between time spreads and inventory holding.
Contango structures make it profitable to buy excess production now and hold it for consumption later so tend to encourage the build-up of stock piles (often highly visible).
But excess supply also results in distressed sales which tend to depress spot prices and push the forward price curve into contango.
In the real world, contango and inventories are co-determined. So the sharp narrowing of the contango over the last three months indicates traders expect far less crude will need storing in the near future.
But it will also encourage inventory holders to reduce their discretionary and speculative stocks since it no longer makes commercial sense to hold them.
The much narrower contango likely heralds a continued and substantial draw down in commercial crude inventories over the next few months.
US refineries are already running at exceptionally high rates, processing well over 16mn barrels per day (bpd) of crude oil, which is 1.2mn bpd above the 10-year seasonal average.
So far, however, strong refinery runs have not resulted in the accumulation of unusually high stocks of refined fuels like gasoline and distillate.
Stocks of gasoline and distillates are only slightly above their long-term averages and tracking normal seasonal patterns closely.
Falling crude inventories, high refining runs, and moderate stocks of refined fuels point to strong consumption at home and abroad.
Senior officials from Saudi Arabia and the major oil trading firms have spoken repeatedly in recent months about the strength of demand since the start of the year.
For the moment, at least, market participants seem confident the enormous build up in crude stocks over the last six months can be successfully digested by the refining system.
There are a number of uncertainties around the outlook.
First, whether demand will continue to grow strongly in the face of a significant increase in the price of crude and refined fuels since the start of the year.
Second, whether the oversupply of crude oil is simply being transformed into an excess of refined fuels.
Third, what happens once the summer peak demand season in the US and Saudi Arabia is over and refineries enter the traditional maintenance season between September and November.
Finally, it is unclear how the market will absorb extra oil exports from Iran in 2016 if a nuclear deal is struck between Tehran and world powers.
With crude stocks already very high any renewed accumulation could cause a big contango to reappear quickly.
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