BY John Kemp
“There is no doubt that the oil market is moving in the right direction,” the Organisation of the Petroleum Exporting Countries noted with satisfaction in its most recent bulletin published
“The rebalancing process was never going to happen overnight; it was never going to happen in a linear fashion; and it was always going to require a concerted effort,” OPEC observed.
“Patience and perseverance are still required”, the bulletin warned, but the organisation is well on the way to achieving the objectives it set when announcing output cuts in November 2016.
Reported oil inventories in the advanced economies have begun to decline towards their five-year average while oil stored at sea and in remote locations has also fallen sharply.
Contango, a symptom of an oversupplied market, has gradually disappeared from most crude markets to be replaced by backwardation, a sign of tightness (http://tmsnrt.rs/2jKOQSM).
OPEC has often stated that it wants to see the contango narrow as part of the rebalancing process.
Contango enables traders to profit from storing crude in excess of their immediate operational requirements by selling oil for deferred delivery at prices above the spot market.
So its disappearance has coincided with an accelerated draw down in inventories held in floating storage and in onshore tanks.
Crude in floating storage has fallen by 30 million barrels since the start of the year, according to industry sources surveyed by OPEC.
Paris-based cargo tracking firm Kpler estimates floating storage has fallen sharply in recent weeks to the lowest level for more than two years.
Oil traders are also emptying one of the world’s largest onshore crude storage facilities at Saldanha Bay in South Africa, according to Bloomberg.
Global crude stocks are gradually being drawn towards the major refining centres as the surplus inherited from 2015-2016 is absorbed.
OPEC’s efforts to rebalance the market have been assisted by exceptionally strong growth in oil consumption in the last three years since prices slumped in 2014. World oil demand has been stimulated by the fall in prices and a synchronised economic expansion in most major consuming countries outside the Middle East.
Global consumption is forecast to increase by 1.6 million barrels per day (bpd) in 2017, after rising by 1.3 million bpd in 2016 and 1.9 million bpd in 2015, according to the International Energy Agency.
Stocks of refined products have tightened, especially for middle distillates such as U.S. heating oil and European gasoil.
Distillate exports from the United States have boomed to meet strong demand from Latin America and other emerging markets.
As a result, U.S. distillate stocks have fallen by 24 million barrels since the start of the year, compared with a normal seasonal rise of 6 million barrels.
Stocks started the year 26 million barrels above the 10-year average but are now 5 million barrels below it and 24 million barrels below the corresponding period in 2016.
With La Niña conditions forecast, which could bring colder weather and more heating demand in the north of the United States between December and February, the U.S. distillate market appears tight.
Refineries in the United States and elsewhere will have to process record quantities of crude in the next few months to stabilise inventories and meet the demand for fuel.
Oil prices have been haltingly moving from contango towards backwardation since early 2015 and certainly since the start of 2016, reflecting the long and winding road to rebalancing.
The shift away from contango to backwardation has accelerated notably since July, most likely in response to Saudi Arabia’s announcement that it would curb exports even further in August and September. Brent futures prices have traded in a sustained backwardation for the first time since oil prices started slumping in July 2014. Brent’s backwardation, initially confined to the contracts nearest expiry, now extends throughout the whole of next year.
Oman futures, an important benchmark for Asia, are also trading in a pronounced backwardation for 2017 and 2018.The only major crude still trading in contango is the U.S. light sweet futures contract (WTI), where the contango has narrowed but shows no sign of disappearing yet. Speculative buying from hedge funds and other traders has probably anticipated and accelerated the shift from contango to backwardation in Brent since the summer.
So the surging backwardation is vulnerable to a correction if and when some of those speculative buyers try to sell some of their positions.
But the basic shift away from contango to backwardation has been underway for more than two years and mirrors previous rebalancing periods in 1998-2000 and 2009-2011. Even if there is a temporary setback, the basic direction of travel towards backwardation should remain intact, provided OPEC continues to restrain its production.