Commodities 2021: Forward-dated crude futures volumes surge as hedging interest returns

New York — Volumes on forward dated NYMEX WTI contracts have turned sharply higher in recent weeks as the return of backwardation in longer-dated crude structure has prompted increased hedging interest by producers, according to sources.

To-date in December, trading volume for the sixth-month NYMEX WTI contract has averaged 63,484 contracts, more than double where it was in November. Trading volume on the year-ahead contract has nearly tripled to 60,406 contracts so far in December.

The surge in volume comes as the WTI forward structure turned notably more bullish amid improved demand outlooks following the announcement of the Pfizer-BioNTech and subsequent COVID-19 vaccines last month.

"This is all about the vaccine - everyone is expecting a tighter supply and demand balance for next year that goes along with textbook post-COVID outlook," OANDA senior market analyst Edward Moya said. "We are finally going to see some normal price curves as we get closer to pre-pandemic life."

Notably the recent bullish turn in forward curves has been mostly the result of a recovery in prompt prices. As of Dec. 17, front-month WTI was trading at levels last seen in late February and was up 30% from early November. However, the year-ahead contract is up a comparatively modest 19% over the same period.

"A lot of things that can go wrong with supply side," Moya said of the COVID-19 vaccine. "Once we get some details on how the vaccine rollout is going, we are going to see that maybe we were a little too optimistic and that could be very disheartening for markets. That could eventually throw this move back to backwardation into limbo."

Securing pre-pandemic prices

The rise in oil prices appears to have sparked a wave of hedging interest as producers attempt to secure pricing at pre-pandemic levels.

"[The price rally is] likely overdone in short term, prices have risen more than supply and demand says they should have," AEGIS Hedging Solutions market analytics director Matt Marshall said. "Anyone that is long oil as a producer needs to hedge to lock in prices and take advantage of prices because they might not be underpinned by supply and demand."

Following AEGIS's acquisition of Risked Revenue Energy Associates, announced Dec. 18, the company advises "over 280 upstream oil and gas entities producing over 6,700,000 BOE/D of crude oil, natural gas and NGLs on over 92,000 hedged positions just in the last 12 months," AEGIS said in a release.

Near-term oil demand outlooks remain under pressure from the threat that a resurgent pandemic could prompt a return to broad lockdowns seen this past spring. Restrictions on business activity exists in more than half the states, and dwindling hospital capacity has forced governments to issue expansive lockdown orders in some of the hardest hit areas, including California.

In its monthly report Dec. 15, the International Energy Agency lowered its oil demand estimates for 2020 and 2021 by 50,000 b/d and 170,000 b/d, respectively, against the backdrop of rising COVID-19 infection numbers and renewed lockdowns. The report came on the heels of OPEC, in its latest monthly oil market report released Dec. 14, revising lower its estimate of 2021 global oil demand by 360,000 b/d to 95.89 million b/d.

But the oil price rally has held despite these dimmed outlooks as the development of multiple COVID-19 vaccines appears to have inoculated markets against the severe downside risks that plagued it earlier in 2020.

"There has been a lot of interest in buying downside protection via put options and those have been bid up, while there has been less optimism about prices going up so call options are less expensive," Marshall said. "For a hedger that's a challenge; insurance for downside risk is more expensive, and the reward for future output is going down."

But this disparity has normalized in recent weeks amid a recovery in prompt crude pricing, allowing producers to create more effective hedges, he added.

"It's going to be a rocky next six to nine months," Marshall said. "It doesn't all depend on demand, but a lot of it depends on the pace of demand growth globally, especially in the western hemisphere through next year."