London, 25 October 2011: Reuters

A day of frenetic spread trading hit U.S. oil futures on Monday, inverting the market's structure for the first time since the financial crisis as traders focused on signs of tightening supplies. After months of talk about how weak U.S. demand and a glut of crude trapped in the Midwest have depressed prices, U.S. futures flipped on Monday to backwardation, where immediate prices are more expensive than deferred contracts, a market structure that usually indicates short-term shortages.

The gap between benchmark U.S. oil futures, commonly referred to as West Texas Intermediate or WTI, and London-based rival Brent also narrowed sharply in one of the biggest one day moves this year. The premium for Brent fell to around $20 a barrel after hitting a record $28 a barrel just 10 days ago.

The shift lacked any apparent trigger, but appeared driven by an abrupt change in market mind-set, fueled by trend-following traders. Analysts pointed to months of steadily declining U.S. oil inventories, expectations of higher demand as refiners begin to ramp up for winter and technical factors. Trading volume in WTI crude surged to its highest level since early May, with contracts totaling more than 1.4 billion barrels of oil changing hands, three times the number of deals done in Brent.

The WTI contract for delivery this December rose as much as 35 cents above the price of contracts for January, and leapt to a near $1 premium over contracts for delivery at the end of 2012. Outright prices surged by $4 to above $91 for the first time since early August. Brent has been in backwardation since March, when the loss of Libyan crude oil started to tighten the seaborne market.

Many traders and analysts expressed shock at the size and speed of the moves. Some said the market was torn between worries about the economy and signs of short-term tightness in the physical market.

"With both Brent and WTI in backwardation, we are seeing how the uncertainty over the economic recovery in general, and European sovereign debt in particular, is leading to the oil market destocking in anticipation of a sharp drop in future oil demand, while current market fundamentals remain very tight," said Dave Greely, Goldman Sachs chief oil analyst in New York.

SPREAD TIGHTENS

The Brent-WTI spread, which measures U.S. crude's discount to global prices , tightened by $2.30 to less than $20 a barrel, its narrowest since July 27. Outright U.S. crude prices were up by almost $4.50 at one point. North Sea production problems and the loss of Libyan oil have inflated prices of seaborne crude, while rising Canadian oil sand and U.S. shale oil production have depressed the land-locked U.S. benchmark in 2011.

Inventories at Cushing, Oklahoma, the delivery point for the WTI contract, also hit a record high near 42 million barrels this spring due to rising Canadian oil sand and U.S. shale oil production, but stocks have tightened since then.

Lawrence Eagles, head oil analyst at JP Morgan in New York, said two key factors were at work: the return of Midwestern refineries from seasonal maintenance, and the limitations on transport capacity to move crude oil to the coast.

"It's fair to say when you have two opposing pricing pressures that both have validity, it creates a potential for pricing volatility," Eagles said. Last Wednesday, the U.S. Energy Information Administration ( EIA) reported that inventories at the oil hub were around 31 million barrels. Total U.S. oil stocks have also tightened, and are also approximately 8 percent lower than the same time last year at 332.9 million barrels, according to the EIA.

Technical trading appeared to drive part of the surge in WTI. Its discount to Brent moved through the 100-day moving average for the first time since October 2010, sparking buying by traders who focus on chart signals and possibly signalling U.S. crude could break out of its downtrend against Brent.

Others said it looked like traders who have profited from the unprecedented blowout in the Brent-WTI spread this year were looking to book profits. "In WTI we are looking at a deflating of the balloon," said Abudi Zein at Genscape, a company which monitors stock levels at Cushing.

"Most of the traders in the spread are momentum players and we are seeing a collision of both the fundamental and the technical. The charts are telling the traders that the writing is on the wall."

Ends --

Reuters - for Commodities Now with permission.