I came across this FT article from several months ago which gives a good picture of where we might be headed in the oil market, as well as in other commodities.  As I described a couple of posts back, the low nominal/negative real interest rates we have been experiencing have incentivized the holding of oil in storage (either in storage tanks or in the ground by not extracting) due to the negative returns available for money which would be received in exchange for the oil.  It has been less expensive to keep the oil in storage than to sell it, especially if one does not have any profitable new business to invest in. 

As rates have flat lined close to zero, oil prices have stayed up in the $95-$100 range since mid-2011.   The forward curve, which was in contango almost continuously from October 2008 until June 2013 (front month minus third month), is now backwardated.  This makes it more expensive for inventory holders to hedge as they have to sell forward to hedge the physical oil they own.  Until June 2013 they were able to capture a hedge profit by selling the higher priced forward and holding it until expiration, when they could buy it back cheaper and roll their hedge forward.  Couple this incentive to hold with the poor alternatives for the cash they would receive from selling their inventories, and the price support becomes obvious. 

Now, however, the forward market for WTI is backwardated and inventory holders must incur a hedge cost when they sell forward at lower prices than spot.  This alone should put downward pressure on spot prices as inventories are sold.  Indeed, inventories at Cushing, Oklahoma continue to decline as oil is sent to the Gulf Coast for either refining or storage.  If refining, this represents demand; if storage, it is just a change in location without affecting the overall level of crude inventories in the US. 

But WTI prices are holding up at around $100.  The normal mechanism would be for the increased supply on the market, induced by a backwardated curve, to push spot prices down until the curve structure is such that holding inventories is cheap enough to slow the selling down.  This hasn’t happened yet.  Is a rate rise what is needed to send prices down to a level more in keeping with what are believed to be supply/demand fundamentals?