(John Kemp is a Reuters market analyst. The views expressed are his own)
* Chartbook: tmsnrt.rs/2EeQkNf
By John Kemp
LONDON, May 16 (Reuters) - Oil traders anticipate a big draw down in crude stocks in the second half of this year as sanctions on Iran and Venezuela coupled with other supply disruptions and a sluggish response from OPEC cause a severe shortage.
Brent's six-month calendar spread has moved into a backwardation of almost $3.80 per barrel up from $2.20 a month ago and a contango of more than $1 per barrel at the beginning of the year (tmsnrt.rs/2EeQkNf).
Brent spreads cycle between backwardation and contango as the market alternates between periods of under- and over-supply, making spreads rather than spot prices the most useful indicator of market balance.
Backwardation is associated with periods of under-supply and falling inventories, while contango is associated with the opposite, so the current backwardation implies stocks are expected to fall sharply.
Brent futures are now in the biggest backwardation since June 2014, when Libya’s oil exports had been reduced to a trickle by civil war and Islamist fighters were threatening the oilfields of northern Iraq.
The six-month spread is in the 94th percentile for all trading days since 1990, indicating traders expect a very large draw down in crude stocks over the next six months.
U.S. sanctions on exports from Venezuela and Iran, coupled with attacks on pipelines and tankers in the Middle East, and the disruption of Russia’s exports due to contamination, have all cut immediate crude availability.
Renewed fighting has increased uncertainty about continued exports from Libya while there is heightened uncertainty about future movements through the Strait of Hormuz as tensions in Gulf regions intensify.
At the same time, U.S. crude production has started to grow more slowly after the decline in prices from last year’s highs and a slowdown in drilling and well completions.
Crude availability is expected to tighten sharply over the next couple of months as U.S. refineries complete their maintenance.
Crude processing is likely to ramp up significantly to meet increased demand for gasoline over the summer and then distillate fuel oil with the introduction of new IMO shipping regulations from the end of the year.
Tighter calendar spreads are usually associated with a rise in spot prices but the recent surge into backwardation has not (so far) been accompanied by a significant rise in front-month futures.
Front-month futures prices have changed little over the last month and remain well below the recent peaks of $80-85 per barrel set last year, even as the backwardation has surged.
Spreads point to an anticipated shortage while spot prices indicate a market expected to remain balanced. Either the backwardation will have to fall, or spot prices will have to rise to eliminate the apparent contradiction.
The anticipated shortage of crude could be relieved by several means (which are not exclusive):
* Saudi Arabia and its allies in the OPEC+ group could increase the supply of crude to the market
* U.S. shale firms could accelerate well drilling and completions to make more crude available
* The United States could ease sanctions pressure on Venezuela and Iran to contain prices
* IEA members could release crude and products from strategic stocks
* Temporary disruptions to production and pipelines could ease
* Consumption growth could slow as a result of economic slowdown
In 2014, the anticipated shortage was eliminated by a combination of higher supply from OPEC and U.S. shale producers, an end to temporary disruptions, and a global economic and consumption slowdown.
Something similar is likely in 2019, though the balance between faster output growth and slower consumption growth remains unclear, mostly because of intense uncertainty about the global economic outlook.
- Oil prices trapped by grim news from emerging markets (Reuters, May 15)
- Hedge funds cautious on oil as economic outlook darkens (Reuters, May 13)
- Oil market will tighten sharply when U.S. refineries return from maintenance (Reuters, May 3)
- U.S. oil output decelerates in response to lower prices (Reuters, May 1) (Editing by Alexandra Hudson)