In one of my recent articles about the oil market, I stated that the withdrawal of waivers for consumers of Iranian oil could lead to a compensating effect on the part of the US supply, which the latest API report on commercial reserves in the US seemed to reflect. In the weekly report dated April 23, the API estimated the growth of reserves at 6.9M barrels with a forecast of -3.9M barrels, which naturally forced buyers to moderate their appetite. It also called for review of the medium-term consequences of White House “harsh” decision against Iran, which may have muted impact on the world supply considering rivalry between US producers OPEC and Russia.
The growth of US stockpiles occurs against the background of “ugly” futures price curve for US manufacturers where contracts for more distanced delivery are cheaper than contracts for the near term (state of backwardation). In this state of the market, it seems that it would be more profitable for American producers not to accumulate reserves, but to sell oil on the spot market, which should lead to a decrease in reserves and, accordingly, their ability to influence futures prices.
Within the framework of non-arbitrage theory of pricing, with deterministic rate and not counting storage costs, futures price is simply an expression of the opportunity cost of holding money (that is, a reflection of lost profit between investing now and in the future):
Where F and S are futures and spot prices for a good at time t, r is a continuously compounded interest rate. The question naturally arises about the possibility of F < S, i.e. backwardation, because then the interest rate r must be negative, which looks impossible.
This, at first glance, contradiction is resolved through an analysis of the state of current vs. future reserves of the good. In the context of contango, when stocks are now higher than in the future, the owner of the goods has a low incentive to sell the goods now, i.e. expects price to rise in the future. In this case, F> S. However, in the case of low stocks now, and expectations of their increase in the future (lower price in the future), i.e. in the state of backwardation, the so-called convenience yield arises – an implicit yield, which I would call the “opportunity cost of selling a scarce commodity”. It should also be noted that if during contango the deficit in the future can be filled through the increased sale of futures contracts, in case of backwardation, you can’t borrow supplies from the future using derivatives. Accordingly, the futures price formula is correct with additional term:
Where c is convenience yield, which can be expressed as an advantage in the form of maintaining current customer satisfaction (since the amount of the is scarce on the market!), ensuring uninterrupted supply, or expecting for an increase in demand for the good on the spot market, etc.
The IEA’s announcement on Tuesday effectively downgraded the value of retiring Iran from the competitive market, stating that world reserves are adequate to demand, and spare global oil production capacity is currently sufficient (to counteract the supply shocks).
Most of the new supply comes from the United States, where crude oil production increased by 2 million barrels from 2018 to 12 million barrels, making the US the largest oil producer, leaving Russia and Saudi Arabia behind. The IEA predicts that in 2019, oil supplies from the United States will increase by 1.6 million barrels.
One sign that US is gradually taking over OPEC’s share was recent delivery of the first tanker to Indonesia, a major Asian oil consumer which was a traditional OPEC customer.