Trading Oil Backwardation & Contango (OPEC Supply)

Hey folks, we are July 7th, 2021. Uh, just some big moves unfolding in the oil market. Obviously we have this week OPEC, uh, really not coming to any decent agreement at their meeting. So the 5.7 million barrel cut, um, is still in effect with no new addition of supply onto, uh, starting from August going forward. Um, but the important thing to note here is the, the effect that this is having on the oil curve, where, whereby a lot of people are looking at $100 oil off of the back of this. Um, so we're going to look at WTI and we're going to look at the trade that would have been on the cards— on the table, sorry, on the table last year when oil went negative. And then we're going to look at what that trade was and how that trade is now unfolding, and also how the current market is looking against the future market 12 months out. So we're going to get into— this may serve as a bit of a tool to learn a little bit more about contango, backwardation, Okay, which is probably one of the more difficult concepts for people to appreciate about forward-looking contracts and futures markets. So let's jump over to the whiteboard, and here we are. So let's just get a couple of, a couple of house items straight here. Okay, so Contango, contango, think up, think from where, think from where you're standing as a person, right? Looking at the market, the market goes up in the future. Okay, we're, you know, present, say, plus 6 months, plus, say, 12 months. Contango. Contango. Right. Okay. Backwardation. Think you guessed it. I think you're looking down, right? The present, 6 months, 12 months. For example, the oil curves actually go out by 2.5, sometimes 3 years, depends on liquidity available and what banks and what some oil trading houses have on offer. at that time. But this is, this is as simple as it is. All right, that's it. You know, you've got an oil curve similar to the way you would have a bond curve or a yield curve, for example, and the different durations. Obviously you have different durations on the, on the bond curve. You've got the 3— well, you've got even as low as a 3-month, 6-month, 12-month bills. Very small timeline delivery to very, you know, to— I think there's 50-year products out there. And in some countries they have— I think there's in the— in South America they've come out with a 100-year bond. I can't remember which country it is. Either way, it doesn't matter. We're talking about oil here. So contango, backwardation, great, got it, tick the box. All right, brilliant. Moving on. Now, if you're in an oil environment, right, whereby we went to zero, where there was so much supply, well, if last year there was just this looming overhang of supply being left in reserve because of COVID no planes flying, no one driving their cars, No one doing anything, no one using oil essentially. Well, you gotta think, well, well, the price went negative, negative $36 on WTI. Okay, all right, we all know that. So when something goes negative that much, um, you know, we negative that much, right? Um, say negative $36. uh, negative 36, right? Negative 36. Well, does anyone think that that's going to be where price— where the price of oil will be forever, or even in 6 months, or even in 3 months, or even the next day? Well, the answer is that if, if you kind of know a little bit about what you're doing at all No, you don't, you don't think oil is going to be at negative $36 forever after, right? And so you can, you, so rather than trading like say spot futures, all right, we trade, there are different, there are different contracts, different ways of trading oil, right? And lots of different products. There's 3 different main 3 different ways to trade futures, really main ways. Well, sorry, sorry, not futures, but to trade this, right? One is spot market, or also known as the cash price. The second is front month, right? In the context of our conversation here, there's really just the three we're going to look at, right? Second is the front month. So right now the front month is the, um, the August Q21 contract, contract. And the third is, uh, is really on the Curve, or, um, what would be the expression to use for this? It'd be like, uh, it'd be like, you know, trading, uh, Curve. Right, curve or calendar. Right, calendar. So we're going to look at this third one, right, and we're going to look at a little bit of the front, front month as well in relation to what I'm going to show you here. So what we're going to look at is the 12-month and 24-month out contract from when oil went negative. All right, so this contract you're looking at here— actually, let me get up, let me get up the right contract so we can show you this properly. Um, let's do the Q21, and it's going to take a little second to get this up right now on the charts because we're loading quite a lot of data here. Um, but just give it a second. So really what I want to illustrate is you could have been buying— in April 2020, you could have been buying oil contracts for delivery August 2021 or 2022 at that time. Now the chart we're looking at here, right, is August 2021 delivery, okay? And this is, this is the shape of that market. This is the shape of that market, okay? And I was explaining this morning that this is the point that oil went negative. Now, if you were forward-looking and thinking at that time, you would buy— you would think, hold on a second, the market has gone so low that I, I just don't believe we're going to stay here for that long in oil. In fact, I think oil is going to be at much higher prices as a result of us not only being negative, but also because of the, the, the way that OPEC has structured their cuts in the market, that it's actually going to have a huge impact on the price of oil for the next 12 to 24 months. And that we're going, we're going to $65, we could even go to $100 on this, because all these companies, as these companies, oil companies come out and say, you know what, because of the OPEC structure now, we're cutting our investment in oil. And because we have so much oil now in reserve, and who knows when COVID will end, we're not actually going to reinvest in discovering oil or, you know, exploration and production, also known as EMP activity or upstream activity, for at least a year and a half. Okay. So then you would think, yeah, okay, I can get on board with that being an extremely tight oil supply picture. So therefore, we should be looking at much higher prices, similar to what I was saying at the time, boys and girls. Okay, fine, here we are. And lo and behold, at that time when oil went negative on the April 2020 contract, it was at this point here on the August delivery 2021 contract. All right, so I could, I could easily go back and load and load up the, um, the, the April— what it would have been, it would have been the, um, J21 or J20 contract here, right? April delivery oil. And that would be this inflection here, which shows negative $36. But if I'm forward-looking enough as a trader, I can go out on the curve at that time in April 2020, and instead of trading the front month I would trade the calendar. So I would trade the August, for example, say, say my view was that it would be August where we would see huge prices in oil, right? For me at the time, I was saying springtime we would see $65 easy. So I would have traded 12 months out, as in April 2021 contract. However, we're now in August and we've had a huge inflection point mass in the country, in, in, in oil. So therefore I want to look at this, this current month that we're trading, front month. However, this, the month we're looking at now, this contract was not the front month at the time. It was the 12-month-out calendar contract. So I would have bought, say, this contract here, and I would have held this contract to the rafters, an expression as in up to the roof, as high as I could as high as the market would push. And sure enough, the analysis on this market, right, shows us that we have a huge, a huge inflection point here. Sound like Donald Trump? Huge, huge line in the sand here for this market. Huge, right? So this is a very good area to take profits, and I'll show you what's happening now trading this calendar. You you're really looking at, say you, uh, well, I'll just show you what happened. The low point to the high, you're looking at about 610% price change on this market. What we've had is also from where we are to the high of yesterday, um, we're looking at, we have 440 days and a price difference of $666, uh, price differential, um, in real terms. Um, but point— well, point being, let's just keep it simple here. But yeah, but it is, it is a— because this contract only went to, uh, $10.52. So if you're catching any of this low here, right, and you're trading the Curve, like say you were stopping out on, uh, this day's let's, let's just zoom in here, right? And this is, this is calendar trading on oil. So you were stopping out on the, uh, on the close of the prior day, uh, you were entering on the open of this day, and then, you know, forget about it. This, this is, this is a big, big, big trade, right? Uh, to where we are at market, saying now you're doing about $134,000 or sorry, $113,480 per single contract traded on WTI. Now, one of the huge benefits to trading calendar, um, and outdated calendars is that you don't have to roll the contract, right? You don't have to roll the contract because the contract isn't expiring for another year. Right? Another, well, another year and a half actually, at April last year. So you don't have to roll it. You do have to identify a large move on the cards. So, so you would be, you would be essentially getting flat on this trade at the end of July when you have to have it roll out, when the August contract essentially will start to, to, to go out and get, and, and you will, and, and cancel and trade out, right? It will no longer be available to trade, okay? And when we get to, when we get to really the, actually the end of August, strictly speaking, or sorry, the start of August, the 3 days before the, the 1st of August, you will have to deliver for that, right? So, um, you, you know, nice trade, eh? Good trade, um, good trade. So that, I mean, the risk reward on this trade, I mean Forget about it, stop there, enter here. You know, I mean, you're doing— by this high of yesterday, it's about 53 to 1. 53 to 1. Okay, so this is how you would trade a calendar on oil or any product, right? Now, the second thing I wanted to talk about was where does oil sit for 12 months from today? Where does oil sit from 12 months from today? Because up until this point, in my view, we have been in contango. All right, later dated delivery of oil is higher priced. Okay, um, as I was saying on the whiteboard, so let's look at what the August 2022 contract, uh, is doing. All right, the August 2022 contract And so what you're going to see here is because, as I highlighted, we came up to such an inflection point in oil, um, on this contract it's what, 76 spot 38s around there, um, 60, uh, yes, about 38s. Um, so because we come to such an inflection point, I've been talking about there is going to be a huge unwind of people who were trading multiple calendar out dates when oil went negative, and they're now liquidating out of those positions. And what we're going to see is over the coming month, you're going to see more of a turn from the industry, from oil being in contango, where the future is higher priced, into backwardation, where actually we're now front month is 76, or sorry, yeah, What are we now on oil? We're, um, $74 right now trading, right? We're at $74, but now because we're seeing— here you go, here is now the liquidation we're seeing in the August 2022 contract delivery, right? Huge selling down on this, take profit taking, huge, right? Because essentially there have been people in April of last year, not only could you buy the August 2021 delivery contract and hold it until the end of this month. But you could also buy the August 2022 contract and hold it until the end of July next year, right? But you're seeing now a huge run for the exits on this huge inflection point for oil. where we are now. I mean, on this contract you would have been doing about, uh, $130,420 per single contract traded. Um, you know, 32 to 1 on, uh, essentially— well, sorry, let's do the same trade. It was roughly, roughly— oh, roughly this trade here. Uh, you're doing about, yeah, 34 to 1 $119,000 per contract traded. But you're seeing a huge unwind now, people taking profits because like me, people are looking at, well, maybe the future is uncertain at this time and we've reached a plateau for the current pricing and we want to liquidate and get out of our contracts and rearrange for trading a contango— or sorry, a backwardation environment. An oil price that's in backwardation, where now the front month is going to be maintained being more expensive than, than any of the calendar months. So this is a confusing topic, uh, backwardation, contango, um, trading oil calendars, but hopefully this serves as a sort of a primer for that, uh, in a way. So Um, yeah, any questions, feel free to reach out to me in the chat room. All right, thanks. Bye-bye.