Determinants of Backwardation in Oil Futures

The paper examines the impact of oil price volatility, the behavior of the Organization of Petroleum Exporting Countries (OPEC), and the volatility of the US Dollar exchange rate on the backwardation of crude oil futures during 1995 and 2006. During the sample period, oil has witnessed strong backwardation 57% of the time and weak backwardation 67% of the time. Our empirical results of weak backwardation show that OPEC production quota and OPEC overproduction have a negative significant effect on oil backwardation, whereas the volatility of the US Dollar against the Euro has a positive significant effect on oil backwardation. As a robustness check, we repeat the regression analysis on strong backwardation and the results do not change qualitatively. The practical implication of our results is that market participants need to consider the role of OPEC and the uncertainty in US Dollar exchange rate in determining and understanding oil backwardation.