Tuesday, March 1, 2016

The Oil Futures Market Is Wagging The Planet

In summary, the spot oil market is saturated, creating a massive spread between one month futures and spot. As the current future rolls towards expiration, oil price collapses towards spot. This creates a massive "contango" spread that generates a temporary tradeable bottom which lasts until around the end of the month...all other global risk assets are along for the ride. Each month the spread between the two closest contracts widens. Shorts are forced to cover since the new front-month contract is already 10% higher than the expiring one. Oil is magically "up" on the day, week etc., along with everything else... 

This entire global charade now hangs upon how much of the daily 2 million barrel oil glut can be profitably stashed offshore, until the glut overflows the spot market again, and the cycle repeats.

Stocks and oil roll over at the beginning of each month, let's figure out why...

S&P 500:


We all know that oil and stocks are at their highest correlation since 1980. And we also know that the recent low in oil coincided with a multi-year widening in the Contango spread. 

So instead of comparing December-March spread, I compared March-April spread which should be minimal. These two contracts traded within $1 of each other up until the roll over to the March contract which took place in January. At the lows the spread was almost $3 i.e. the front-month expiring contract collapsed down which temporarily "facilitated" the storage arbitrage trade and short-covering...

March-April (red) with WTI:
(These two contracts were not as relevant back in August, but the circle shows that the same game was played back then coinciding with expiration...)

Now look at expiration of the February contract in January, although smaller spread $1.57...


On the day of expiration, February traded -10% lower than March. 

February and March contracts:

The March-April rollover funded this latest rally...

KA-CHING!!! Money in the bank. Time to cover, bitchez...

The March - December Spread: $11

Every time this game is played, oil bounces, but then makes a new low as the next expiration approaches usually around 3rd week of the month. 

"That's not a spread, this is a spread"
The current April-May spread, versus March-April:

Stocks with oil: