Today Pete takes a look at energy forward curves, what they represent and what they mean to traders.
First Pete breaks down the relevance of energy forward curves for various market participants. For physical traders the curve represents much about the inventories of the product relative to storage capacity. For tank storage companies the demand for their tank capacity will be dictated by shape, with contango indicating high demand and backwardation indicating lower demand. For futures traders the curve is utilized for placing speculative spread trades.
Some key points regarding energy futures curves are:
- The shape of the curve: Upwards sloping = contango Downward sloping = backwardation
Shape is persistent and typically isn’t impacted by daily swings in the futures prices.
Crude and Oil products forward curves are linked.
Pete also analyzes what drives the front and back end of the futures curve.
The back end of the curve is driven by fundamentals of both supply and demand. The supply side is driven by a price that justifies investments in exploration and development of oil wells. The demand side is driven by a pricing that justifies investment in programs for alternative energy.
On the front end of the curve, supply and demand in the near future dictate the pricing, as do current and expected inventory levels.
Lastly Pete explains the concept of a storage arbitrage play, not easy for the individual investor, but interesting nonetheless.