What contango unwinding looks like…

by Attain Capital

While there has been much written about Crude Oil’s spike above $100 on the back of the news out of Libya, we haven’t seen much on what the spike has meant for the entire Crude “curve”, meaning the further out contract months (Crude has open interest all the way out to the December 2019 contract)

While most investors could care less about what the December 2013 Crude contract is doing, spread traders such as Emil Van Essen who bet on contango conditions persisting can see their month’s made or broken with moves such as we have seen recently.

For a refresher, a futures market in ‘contango’ is one in which further out contracts are more expensive than nearby contracts. Crude Oil was a poster child for Contango this time last week (see chart to the right)

Fast forward a week…and we see a much different looking Crude Oil

curve, with the near months having spiked, while the back months have essentially stayed in the same place.

This is consistent with a supply shock type event where market participants believe there hasn’t been a secular shift in price dynamics affecting prices going out 8 years,  only a short term supply problem traders believe will affect prices in the next 3 to 6 months.

When looking at the past week’s price activity in another way (% gain/loss since last Thurs through last night), we can see quite clearly that the gains have been concentrated on the next 9 months futures contracts – with the further out months actually falling since the Libya news hit…. yet we don’t hear on the news how this is likely just a short term knee jerk reaction.

The chart above is exactly the kind of market spread traders betting on Contango don’t like to see, with a supply situation causing a spike up in the near months not matched by the further out months – and sure enough – spread trader Emil Van Essen has had a tough week, losing about -4% via short Dec 11/long Dec 12 spread.  The silver lining – the same thing is likely to happen in reverse when and if prices reverse, with the nearer term contracts moving more (either up or down) than the further out contracts.  And… this is setting up nicely for the next round of trades…