Storage and Inventories

Inventories, the stocks of a commodity held in tanks, warehouses, silos and vaults, are the buffer between supply and demand. When inventories are high, short term disruptions are easily absorbed and prices tend to be calm, with futures curves in contango. When inventories are low, any disruption can cause sharp price spikes and curves move into backwardation. Watching inventory data is one of the most important habits of commodity traders.

The theory of storage#

Economists Nicholas Kaldor, Holbrook Working and Michael Brennan developed the theory of storage, which links inventory levels to the shape of the futures curve.

The convenience yield is the benefit of holding the physical commodity, such as keeping a refinery running in a shortage. When stocks are scarce, that benefit rises, and spot prices rise relative to futures. See Contango, Backwardation and Spot vs Futures.

Days of supply#

Analysts often express inventories relative to consumption:

days of supply = inventories / daily consumption

or in grains, the stocks to use ratio:

stocks to use = ending stocks / annual use

Key inventory reports#

Markets react to the difference between reported changes and analysts' expectations. See Trading Economic Releases.

When storage runs out#

Storage capacity is finite. When it fills up, holders of physical commodities cannot find anywhere to put new supply, and near term prices can collapse.

In April 2020, demand for oil collapsed during COVID lockdowns. Storage at Cushing, Oklahoma, the delivery point for WTI futures, neared capacity. On 20 April, the expiring May WTI contract settled at minus $37.63 a barrel: holders paid buyers to take oil off their hands. Traders even chartered oil tankers as floating storage. See Crude Oil and Physical Delivery vs Cash Settlement.

Visible and invisible inventories#

Not all inventories are reported. Stocks held by consumers, in transit at sea or in countries with limited data are "invisible". China's commodity stockpiles, for example, are hard to measure, which adds uncertainty to global balances.

Trading with inventories#

• Fundamental trading: buy when inventories are tightening faster than expected, sell when they build.
• Spread trading: low inventories favour bull calendar spreads (near month strength). See Calendar Spreads in Futures.
• Event trading: trade the weekly or monthly report surprises. See News Trading.
• Cash and carry: when contango exceeds storage costs, store and sell futures. See Cash-and-Carry Arbitrage.

Frequently asked questions#

Why do inventories matter for commodity prices?#

They are the buffer between supply and demand. Low inventories make prices more sensitive to disruptions and push curves into backwardation.

What is the stocks to use ratio?#

Ending inventories divided by annual consumption, a key measure of tightness in grain markets.

Why did oil prices go negative in 2020?#

Demand collapsed and storage at the WTI delivery point was nearly full, so holders of expiring futures paid others to take delivery.

Next, explore the largest commodity sector in Energy Markets.