Crude oil surges on improved outlook

The price of prompt WTI crude has broken above previous resistance after a 21 percent rally since early October. The rally has primarily benefited the front end of the oil curve with the price of oil for December delivery surging above previous resistance at 91 dollars per barrel. The change in the shape of the forward curve over the last seven days has been quite dramatic resulting in the spread between current month and next month turning positive for the first time since September 2008.

The chart below shows how the rally in WTI crude over the last week has primarily benefited the near months and how the forward price projections have shifted. 
Source: Bloomberg

This shape of the forward curve, called backwardation, where it is more expensive to buy now than later is signalling a tightening between supply and demand. This underlying tightness has been seen over the last couple of months but with traders more concerned about the potential for recession oil prices had been under pressure for a while. As tightness was already a problem in Brent crude due to the Libyan conflict, production outages in the North Sea and continued strong demand from emerging markets traders instead expressed negative views through WTI crude which reached a low of 75 dollars just a few weeks ago before recovering.
 
The surge has not least been helped by improved economic data from U.S. and China, the world’s two largest consumers. European plans to contain the spiraling sovereign debt crisis should be announced Wednesday and a failure to deliver decisive measures pose the biggest downside risk near term. A curve in backwardation is good for oil investors as they receive a positive roll yield when rolling holdings from current month to the next, something that investors in Brent have benefited from during most of 2011.

Technically WTI crude has now moved from a negative to a neutral stance after the move above 91 dollars yesterday. Much of the move has probably been driven by short covering after investors have been forced to alter their views on the risk of a recession. Baring any negative news from the European debt meeting Wednesday it could now target the 100 to 105 area over the coming weeks.