Market Report: Oil Market Dances the Contango

Say good-bye to the May crude oil futures contract that went out in an impressive rally and a mission to close the wide spread between front end of the crude curve.

The oil market has been going contango crazy in recent weeks as bullish construed hopes ran high. Those dreams seemed to gain momentum when crude surged to a 17 month high in a volume deprived holiday week. Of course that was a precursor to near record volume and the inspiration that Iran might take oil and store it in tankers. Yet the lack of follow through caused the spread to come in dramatically.

John Kemp, a market analyst with Reuter's News, said that the abrupt widening of the contango in crude has wrong-footed a large number of traders, if the big spike in NYMEX volumes is anything to go by. Kemp says that the consistent rise in prices, and increasingly bullish prognosis, almost certainly drew in a large number of trend-following technical traders in size, hoping to ride a sustained rally.

The subsequent breakdown of the rally would have probably triggered downside stops set to lock in profits on the trade. But Kemp theorizes the daily price changes were relatively small. In fact, volatility was falling to some of the lowest levels witnessed in the past decade during this period. Unless stops were being placed unusually close to the market (signifying nervousness among the trend traders) or the technical funds were present in the market in unusual size, they could not account for so much concentrated turnover on such a small price move.

But while movement in price was small, Kemp points out that the moves in spreads were much bigger, certainly big enough to flush out any fundamental or technical trader. Kemp says that many traders expected the spread to shrink further or turn negative and leading analysts predicted that the market would flip from contango to backwardation as a result of a tightening supply and demand balance and the continued drawdown in stocks. Instead the spread flared out rapidly and massively. In seven trading days the spread between the May-December strip soared! Interesting take by Reuters.