What the oil futures curve is currently telling us

Spot prices, or front-month contracts, are generally the most closely watched by investors, although they are insufficient to understand market projections over time. To read trader expectations, one must look at the futures curve, i.e. the prices negotiated today for future delivery.

The futures curve for a commodity provides useful insights into how markets assess the future balance between supply and demand. It reflects not only a forecast for the commodity, but also storage costs, financing, risk premiums and the convenience yield associated with the immediate availability of a barrel. However, the principle remains relatively simple: the front-month contract primarily reflects immediate tightness in the physical market, while longer-dated maturities, such as those for the end of the year, indicate whether operators believe this tension will persist.

At present, the most interesting signal comes from the sharp backwardation in Brent, meaning that near-term contracts are trading significantly above longer-dated ones. Under normal conditions, the spread between the first two maturities is limited to 0-2 dollars. Yet this spread has surged since the escalation of tensions between Washington and Tehran in late February and early March, even reaching $14 at the peak of tensions in March.

Despite the zigzagging trend in oil prices since the truce in early April, the spread between the first two maturities has narrowed significantly. This reduction might seem reassuring at first glance, but it is actually occurring because long-dated maturities are catching up to short-dated prices.

This development is significant because longer-dated prices tend to have a greater influence on the decisions of economic agents. A refiner, an airline, or an industrial player can ignore a very brief spike in spot prices if it appears temporary, but they can no longer do so if prices for three, six, or twelve months out are also rising. In such a case, the market is no longer merely anticipating a short-term shock, but rather a more persistent supply constraint likely to be passed onto final prices, the margins of energy-intensive companies and inflationary expectations.

For central bankers, this distinction also changes the risk assessment. A price increase concentrated on the front-month contract can be treated as a one-off shock, even if it remains uncomfortable. A rise in long-dated maturities more forcefully requires considering a lasting inflationary shock and, consequently, potential monetary tightening.