Futures prices for crude delivered in October climbed to $90 per barrel on Sept. 14, up from $68 on June 27, as traders anticipated increasing shortages of unrefined petroleum.

The three-month calendar spread from October 2023 to January 2024 tightened to a backwardation of $2.26 per barrel from just 10 cents, as inventories were expected to deplete further.

Calendar spreads are inversely correlated with inventory levels, so the increasing backwardation - when spot prices are higher than forward prices - was expected given the rapid draw down of inventories around Cushing.

Until recently, Cushing was the “pipeline crossroads” of the United States, a major storage and logistics hub for the domestic production and refining system; inventory changes there tended to reflect wider market conditions.

In the last decade, however, pipeline and storage activity has shifted to the Gulf Coast as the U.S. oil industry has become increasingly oriented towards exporting crude.

As a result, inventories and prices at Cushing are no longer necessarily representative of conditions in the wider market.

LOCAL DEPLETION

Since the end of June, inventories at Cushing have depleted much faster than at other locations around the country.

Cushing crude stocks have depleted by 18 million barrels (-42%) since the end of June compared with just 14 million barrels (-3%) elsewhere.

Cushing accounted for less than 10% of all nationwide inventories at the end of June but it has seen 57% of the total depletion since then.

As a result, Cushing stocks were 16 million barrels (-39% or -1.05 standard deviations) below the ten-year seasonal average on Sept. 8 with the deficit up from just -1 million (-2% or -0.06 standard deviations) on June 30.

Chartbook: U.S. oil inventories

By contrast, national commercial crude inventories were still 1 million barrels above the seasonal average on Sept. 8, down from a surplus of 10 million at the end of June.

In Europe, crude and other feedstock inventories actually increased by 6 million barrels (+1%) between the end of June and the end of August, according to data published by the European Commission.

So the rapid depletion of inventories at Cushing has forced U.S. futures prices and calendar spreads higher, but it may be exaggerating the tightness of supplies across the rest of the country and around the world.

POSITION BUILDING

U.S. petroleum inventories are the most visible and closely watched in the world because they are reported weekly with a delay of just a few days, compared with monthly reporting with multi-month delays in other countries.

Changes in U.S. inventories are often used as a proxy for the global production-consumption balance because of their greater visibility and timeliness.

Changes in stocks held around Cushing get even more attention because of its former importance as a logistics hub and its function in the NYMEX futures delivery process.

Hedge funds and other money managers have responded to inventory depletion and escalating prices by reducing former bearish short positions and establishing new bullish long ones in U.S. crude futures and options.

Short positions were cut by the equivalent of 111 million barrels (-65%) between June 27 and Sept. 5, according to position records filed with the U.S. Commodity Futures Trading Commission.

Long positions in WTI futures contracts were boosted by the equivalent of 68 million barrels (+32%) over the same position.

In consequence, the net position in WTI climbed to 225 million barrels (42nd percentile for all weeks since 2013) up from a record low of just 46 million barrels.

Hedge fund purchases have anticipated, accelerated and amplified the rise in U.S. crude prices as the investor community has tried to position itself for a period of shortages.

Fund positions tended to be concentrated in the contracts closest to maturity because they offer the greatest volatility and liquidity, so buying has turbocharged the rise in spot prices and march towards steeper backwardation.

HOW REPRESENTATIVE?

Saudi Arabia and its OPEC+ allies have cut production by well over 1 million barrels per day since the start of July, in an effort to reduce global inventories and boost prices.

The cuts removed a total of 85 million barrels from the market in July and August and will reach 245 million by the end of 2023 if implemented in full.

Saudi Arabia has steered its remaining exports away from North America and towards Asia through differential increases in its official selling prices.

This strategy reserves a higher share of reduced exports for refiners in Asia, strategic partners which buy guaranteed volumes on long-term contracts.

Simultaneously, it reduces the flow of crude to North America, the fastest way to have a visible impact on global inventories given U.S. stocks are reported weekly.

There is still a question about why inventories at Cushing have fallen so much faster and further than in the rest of the United States.

Inventories around the NYMEX delivery point tend to be more volatile than stocks across the nation as a whole so the discrepancy is not unexpected.

It is possible Cushing inventories are being liquidated to make up for reduced flows from Saudi Arabia and other Middle East exporters.

But it is also possible one or more traders is intentionally liquidating inventories at Cushing to accelerate the rally and shift to a strong backwardation.

Related columns:

- Depleting U.S. crude stocks draw in hedge funds (September 11, 2023)

- Hedge funds buy U.S. crude as stocks fall (September 4, 2023)

- Depleting U.S. crude inventories lift oil prices (August 31, 2023)

John Kemp is a Reuters market analyst. The views expressed are his own