London, 27 May 2010

The NYMEX light sweet oil contract has been heavily criticised as a misleading benchmark for the global oil market. One bank has likened its usefulness as an international reference price to a "chocolate teapot" because NYMEX is more influenced by idiosyncratic factors around the delivery point at Cushing (Oklahoma) than the worldwide supply- demand balance.

Recent "distortions" at the front of the NYMEX futures curve have been cited by many analysts as a case in point. Rapid inventory builds around Cushing, and a looming shortage of tankfarm space for physical deliveries, pushed front-month prices to a $4.60 discount against the second month earlier in May.

Similar negative spreads appeared against Brent and other international benchmarks such as Tapis and the weighted basket of OPEC crudes.

Many commentators blamed the divergence on "congestion" around the delivery point and suggested it overstated the degree of slack in international oil markets.

Other spot crudes were a more accurate reflection, in their view. NYMEX timespreads and discounts to other benchmarks would narrow as rising refining runs stemmed the Cushing stockbuild, front-month light sweet prices rose to a more normal level, and pricing relationships "normalized".

In recent days, spreads have indeed come in -- but not in the way analysts predicted. Instead of nearby NYMEX prices rising, prices for forward contracts and other international benchmarks have fallen to meet them.

Rather than a chocolate teapot, stocks around Cushing and the WTI contracts have acted as a "canary in the mine", heralding forthcoming weakness in the international market.

The huge contango in NYMEX light sweet oil has narrowed. Not because nearby prices have risen but because forward prices have weakened and caught up with earlier declines at the front of the curve.

Likewise weakness first evident in WTI has now spread to Brent and other international benchmarks. WTI may have led the way down, but the rest of the market has followed it.

While the July NYMEX contract has fallen just $4.47 between May 17 and last night's close, July Brent was down $5.55, and the OPEC basket fell $6.41. The discount for July NYMEX compared with Brent has narrowed from a recent high of $2.50 to just 52 cents since the middle of the month.

WTI's critics argue two separate processes were at work -- "dislocation" followed by "de-risking". In the first phase, from the start of the month until last week, congestion weighed down the front end of WTI and caused it to de-link from other oil prices. In the second, more evident in the past fortnight, rising risk aversion and concerns about the pace of the global recovery have brought all oil prices sharply lower, in line with equities.

But that does not explain why Brent and other benchmarks have been hit harder than WTI in the last fortnight. WTI and stockpiles at Cushing may have been a better international marker than many of its critics give it credit for.

In particular, rising stocks at Cushing provided Cassandralike warning global markets were not as tight as some thought, and it is unwise to ignore them.

Ends --

By John Kemp, Reuters market analyst - for Commodities Now.

The views expressed are his own.