Crude Oil Futures Backwardation Spike

Crude oil prices are showing at least a short term topping condition now, based on seeing the near month (February 2025) contract price well above that of January 2026.  This produces the big spread that you see in this week's chart., which says that prices have become stretched to the upside.

Any futures contract represents 2 positions simultaneously, one long and one short, each held by different people.  The short position holder is obligated to "deliver" the specified amount of the subject commodity at a time and place identified in the futures contract.  For crude oil the delivery site is the giant oil storage facility in Cushing, Oklahoma.  If the short position holder does not want to have to make delivery of the product there, then he has to find someone else to purchase that contract before it reaches the expiration date.  The holder of the long side of that contract is similarly obligated to accept delivery at the specified location, or sell that contract before expiration to get out of that obligation.

In soft commodities like energy or grains (as opposed to gold or silver, for example), there can arise supply constraints affecting pricing of the near month contract in ways that we do not see in the more distant month contracts' pricing.  Crude oil futures famously traded below zero in April 2020, as the Covid Crash and associated economic shutdown led to a sudden drop in oil consumption, and Cushing ended up filled to capacity.  So the traders who were long crude oil and who could not find a place to store the oil that they had to take delivery of were suddenly in big trouble.  That negative pricing did not extend to the other contracts, just the expiring one in April 2020.

That is not the condition we see now, as the current near month (Feb25) contract is priced at $78.77/barrel, but the Jan26 contract is at 69.73.  There is a minor shortage of deliverable oil right now, and thus traders are scrambling to line up supplies they need to feed oil refineries.  That makes the price of the near month contract go up, while these momentary supply issues do not have much of an impact on the farther out contracts.

This type of spread is known as "backwardation" because it is backwards from the normal circumstance of having farther out contracts priced higher.  When that condition is in effect, it is referred to as "contango".  If contango ever gets really large, the speculators can make money by purchasing crude oil in the spot market and arranging to store it somewhere, while selling distant futures contracts for a higher price.  They get to profit from that difference in pricing, as long as it is big enough to cover the storage costs.  At truly wild contango extremes, traders have even rented oil tankers and stored their oil at sea.

In the current condition, though, nobody is renting oil storage to sell their oil later, since the price is higher now than for the later contracts.  The supply squeeze pushes up the near month price.  When that push extends too far, you see an extreme like we have now, where the near month price is really far from the more distant months' contract prices.  These episodes pretty reliably mark at least short term tops for oil prices, because they reveal an extreme which cannot continue itself very long.  Whether it turns into a larger price top is not something that this spread alone will tell us; for that we have to turn to other factors.  But this should produce at least a momentary top in oil prices.

For more on the topic of contango vs. backwardation, see this article from our web site's Learning Center:
https://www.mcoscillator.com/learning_center/kb/economic_relationships/contango_backwardation_in_oil_and_gold/