Thread by @PauloMacro

A thread on oil and curve structure.

You may have seen me write before how “the curve always tells the truth” as part of my view going back several months of a growing divergence between physical and derivative commodity markets that has now been widely acknowledged.
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I often look at 2nd vs 3rd month because the front month roll and expiries can get very noisy and messy. Here I show you the 2nd minus 3rd month ($/bbl), back to June 2020 only because the super contango in spring 2020 makes more recent timespreads hard to see on a chart:
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The white line above shows you the current $1.40 backwardation between 2nd-3rd. As you can see we flipped to backwardation right at the start of last year (green), and despite the $10 two-day accident this week, the market is punishing storage and calling supply to come out.
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A better view is looking at the same timespread in % terms. Here the white horizontal line marks today’s 2nd/3rd month backwardation of 1.5%. With exception of Feb 11-Mar 31 and May 1-July 31 this year, the market has not been this tight since flipping backwardated in Jan2021:
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This chart shows you the % backwardation back to the flip in Jan2021, averaging 2% recently.
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Most who disagree with my “pounding the table” seem to suggest that demand destruction explains these selloffs — but this is not supported by the curve because if it were true, we would be collapsing like 1Q2020 into contango and requiring storage.

That is not happening.

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So with the above in mind, you can begin to understand why pros like @AndurandPierre have recently been pulling their hair out in public with a giant “WTF is going on”…
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https://twitter.com/AndurandPierre/status/1564929841299951619

…while others are even hinting at theories of US govt intervention to suppress paper markets ahead of midterms (the Saudis recently came close to saying this part out loud in their veiled threats to cut production as an offset to SPR releases).
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Simply put, speculators are having trouble accepting this divergence between the paper market which shows remarkable volatility AND downside bias versus an ever-tight physical market that continues to draw inventory out of storage.
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I wholeheartedly agree with @INArteCarloDoss that it is at junctures such as this that we want to be especially careful not to get sucked into conspiracy theories or emotions.

I do NOT believe the mkt is “broken.”

But it has definitely CHANGED REGIME.

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https://twitter.com/INArteCarloDoss/status/1564988607697506307

For the years spanning nearly all careers of today’s market participants, the oil market has been continuous, and despite occasional bursts of significant volatility, outcomes were bounded.

Covid’s super contango and negative WTI prices changed this regime forever.

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Oh yes…Remember those kooks who ranted in April 2020 about how letting prices go negative was an expediency that might make sense in the moment but might also have insane harmful, unforeseen consequences?

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Well voilà - I give you the paper/physical unhinged regime of 2022.

There is a straight line from April 2020 negative prices to the screwed up oil market topology we have today. So what does this all mean?

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I have written about this previously here… many of you liked this one and was probably my first thread to go truly viral:

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https://twitter.com/PauloMacro/status/1505229293856735241

We keep hearing the refrain of how the liquidity in all assets is terrible and it is not just a thin summer thing - it goes back all year and even longer.

The liquidity in commodity derivatives is *horrendous*.

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The fact that we are suddenly seeing $5+ daily swings in crude on the downside after many weeks of declining vol is giving many the impression that this is somehow indicative of a deflationary 2008 recession just around the corner.
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I think this view is wrong, and that this resurgence in vol is a very dangerous sign that the marketplace’s function of price discovery is having some trouble in coping with the crosswinds of positioning, rebalancing, and another bouts of forced degrossing…
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…and that the current equilibrium pricing is highly unstable.

The physical market has *not* loosened. The curve ALWAYS TELLS THE TRUTH. These reemerging microbursts of windshear are telltale signs of discontinuity that seeks to resolve a chaotic divergent condition.
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The physical market will always be the gravity that forces an eventual convergence with derivatives, because it is the collateral upon which the entire edifice of the market is built.
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Imho the oil market is coiled for a dramatic move higher and I have been aggressively positioning this week in expressing this view.

I make my share of bad calls and surely will eat plenty of crow for so visibly calling this one.

*Take NONE of this as financial advice.*

/FIN