It has finally happened. In these uncertain times maybe not much should be read into it but a phenomenon not seen since the beginning of January 2020 has occurred. None of the five major oil futures contracts display contango on the front-end. The last one to get in line was ICE Gasoil, where the September contract settled a few ticks above October. Of course, there are solid fundamental reasons behind this seemingly encouraging development.
For the two crude oil markers, continuous global stock draws that are the function of OPEC+ supply management and the fragile demand recovery attracted investors ever since the first vaccine was developed last November. The latest OPEC report has put OECD stocks at the end of 2Q 290 million bbls lower than the same period in 2020 and 90 million bbls below the 5-year average. Global oil demand, on the other hand is set to grow by nearly 6 mbpd year-on-year. WTI has also been supported by depleted Cushing oil inventories. On the product front, the backwardation in RBOB persists due to the ongoing summer driving season greatly helped by fiscal stimulus that has put hundreds of thousands of motorists on the road. The disappearance of contango in Heating Oil and Gasoil is the unmistakable sign of the approaching winter in the northern hemisphere.
Judging by the structures of the future contracts the burgeoning confidence is here to say. WTI and Brent are backwardated all the way down to 2027-2028. The RBOB contract flips back to contango in 2024 (ignoring the quality change every April) and Heat and Gasoil are both in backwardation until after the first half of next year when they switch to contango due to their seasonal nature. When the front commands a premium over longer dated contracts, it is usually the sign of physical tightness. Which begs the question, why outright prices are not much higher, at least challenging the peaks we saw last months.
Again, there are well established reasons for this hesitancy that were on full display last week. Firstly, the pandemic is far from being contained. There are surges in cases in different regions in the world and with the school year just about to start in several Western countries spikes in infections are reasonably anticipated. In the US hospitalization rose to an 8-month high. The Delta variant of the virus was one of the reasons for the sell-off that ended last Monday and it might well trigger another bout of stampede towards the exit if infection rates keep rising as expected.
The next step of the Federal Reserve is also being eagerly watched as any sign of scaling back on the bond-buying programme and withdrawing monetary support will strengthen the safe haven status of the dollar, which dents physical oil demand nearly all over the world. The chairman of the US central bank, Jay Powell did a good job on Friday afternoon to calm nerves when he declined to provide a clear timeline for cutting back on asset purchase, although he acknowledged that significant progress has been made to reach the average 2% inflation target and full employment. The clear concerns of policy makers are whether inflating consumer and producer prices are on a transitory ascend or an early increase in interest rates is needed to keep inflation in check. Stock markets rallied and the dollar weakened after Powell’s Jackson Hole speech on Friday and yesterday, but the consensus is that tapering will start well before the end of this year.
The Taliban takeover of Afghanistan can be viewed from a million angels. Its impact on the global economy is debatable and will unlikely be felt in the short-term. The fact, however, that the broken moral compass of the West guided US troops back home and left the locals in hands of an unelected religious group with ties to terrorist organizations and it does not bode well for investors’ sentiment. Secondly, American military deaths during Thursday’s suicide bombing around Kabul airport has put an enormous pressure on Joe Biden with his approval rating falling at the time when he is keen to push through his domestic infrastructure and budget packages, crucial to maintain economic growth and narrow inequality.
The oil market and it structure showed its optimistic face last week. Undoubtedly, Huracan, the Mayan god of wind, storm and fire provided an unwelcome support for oil prices as Pemex was forced to shut in 420,000 bpd of its production due to a fire on one its offshore platforms. Hurricane Ida left 1 million people without electricity, knocked out 1.7 mbpd of oil and 2.1 bcf/d of natural gas production in the Gulf of Mexico. Refiners with a combined production of nearly 2 mbd were shut or significantly reduced operation. The Colonial pipeline briefly halted gasoline deliveries and shipping ports, including the Louisiana Offshore Port, suspended operation. Despite the devastating impact of the hurricane the price reaction was muted. An early morning rally was followed with a sell-off although prices recovered later on the day. What is dead cert is that the upcoming two weekly EIA statistics will show sizeable falls in crude oil production, exports/imports and refinery runs in PADD 3 with product inventories likely to decline.
As Mother Nature is taking a breath attention is shifting to the slowing expansion of Chinese manufacturing activity and to tomorrow’s OPEC+ meeting where the planned 400,000 bpd increase in the group’s production ceiling will be debated. The focus will be on the recent price slump. The Kuwaiti oil minister suggested that the alliance might consider icing the first batch of production increase due to the adverse economic impact of the latest wave of the coronavirus although with Brent back above $70/bbl such a reversal will come as a surprise.
Last week’s recovery from the $13/bbl slump was impressive and the backwardated futures market implies prolonged confidence. However, unless the pandemic is knocked out investors, albeit they refuse to turn bearish on oil, will not be shy to get rid of length, just like they did the weeks before last if the goal post is kept moving away.