If the impact of the Delta variant of the coronavirus has ever been in doubt it is enough to have a quick glance at the performances of assorted stock indices. The MSCI Asia-Pacific (excluding Japan) index has lost more than 4% this month, whilst the S&P 500 index has gained nearly 3%. Asian economies are negatively affected but the developed part of the world is resilient. This uneven impact is the reason why investors are keeping a portion for their gunpowder dry but at the same time why they refuse the panic.

The bumpy economic recovery unavoidably makes its presence felt in the oil market, too. The splendid recovery experienced in the second half of last week slowed somewhat yesterday. Clearly, concerns about rising Chinese infections and the consequent danger of slowing crude oil imports are capping gains. The multi-year highs reached at the beginning of the month are some way above the current price action on crude. The general consensus, however, is still continuous supply deficit in coming months but the magical $80/bbl price target basis Brent currently seems more plausible to be reached towards the end of the year, rather than in the incumbent quarter.

Solid structures imply stable investors’ confidence

Investors’ confidence that was running high up until the beginning of last week has been shaken a little bit of late. There have been two reasons for that. Firstly, the rapid spread of the Delta variant of the coronavirus is causing unease amongst market players as demand forecasts might have to be revised downwards due to the re-introduction of lockdowns and mobility restrictions all over the world. Secondly, although the uncertainty within the OPEC+ alliance was dealt with last week, it is still a source of unpredictability, mainly because of the Iranian wild card. Both the demand and the supply side of the oil equation faces, well, not necessarily headwinds, but turbulence and these undoubtedly weigh on investors’ sentiment.

The move higher came to an abrupt end last Monday when oil prices were pushed over the precipice. As brutal as the sell-off proved to be it did not last long. The agreement struck by OPEC+ has removed a great deal of uncertainty from the market and the general view is that the global oil balance will remain tight for the rest of the year.  On the demand side worries about the relentless spread of the virus seem justified but it is worth remembering that these concerns have not had a long-lasting negative impact on optimism in the past.

In fact, this optimism in 1H was admirable. The performance of the five main oil futures contracts was spectacular in the first half of the year although physical markets did not justify such an unabated rise in outright prices. The best performing contracts were WTI and RBOB with returns of around 53% in the first six months of 2021. They are followed by Brent (+49%), Heating Oil (+44%) with Gasoil lagging with a gain of 39%. The interesting aspect of these impressive returns is that historically such a rally is usually coupled with strong market structures but this time it was only the European crude oil benchmark that added extra profit to the performance by rolling positions from one month to the next. Structures of the five main oil futures contracts, however, are firming or at least are resilient suggesting limited downside potential amid the latest virus outbreak.

The average backwardation of the front-month spread was 42 cents/bbl on Brent between January and June. It resulted in an extra profit of $2.52/bbl in the first half by rolling length six times. The extent of the backwardation remains healthy for Brent spreads – it is above 80 cents/bbl for the first three spreads. In WTI the same average was a mere 11 cents/bbl although it has to be pointed out that from May onwards the US crude marker has been making amends and the front-end backwardation has gotten close to that of Brent from time to time. The WTI structure got hit yesterday despite depleting Cushing inventories but the weakness that characterized its time spreads in the first half of the year is nowhere to be seen now.

Heating Oil produced an average backwardation of 9 points (2 cents/bbl equivalent) whilst the front spread on Gasoil was a contango of around $2/tonnes. Both contracts still display marginal contango on the front-end, but it is turning into backwardation further down the curve. The average 1H contango of 142 points on RBOB is misleading because the specs change from winter to summer grade at the end of February caused a steep discount in the March contract against April, something that will be offset in August. The US gasoline market has come alive in July and the now there is a healthy backwardation of 330 points between the first two months.

The rally in the early half of 2021 was based more on perception than on actual tightness. The structures, however, have strengthened considerably on both crude oil futures contracts in the past two months implying genuine physical shortage and healthy demand from refiners. It is reflected in rising US weekly crude oil inputs that are the highest on a 4-week average basis since the beginning of 2020. Products have started to follow the tightness in the crude structures. The fact that RBOB spreads are now backwardated is encouraging and shows demand improvement for gasoline in the US. The slight contango in Heating Oil and Gasoil at this time of the year will not come as a surprise but this front-end discount is still narrower than during the comparable period of 2019 and 2020. Recent encouraging developments in time spreads in the futures market send out a message loud and clear: retracements caused by the worries about demand considerations will be limited in price as well as in time, just like last Monday and will only delay but not reverse the march higher.