Column: OPEC output restraint tightens oil inventories and spreads

OPEC output
If OPEC output cuts remain in place, the oil market will tighten significantly in the second half of 2018. Photo by Mike Goldwater"

If OPEC output cuts stay in place, market will tighten significantly in second half of 2018.  OPEC photo.

OPEC output cut targets a reduction in global crude stocks

By John Kemp

LONDON, Jan 25 (Reuters) – OPEC and its allies insist more needs to be done to reduce global oil inventories but the market already shows unmistakeable signs of becoming very tight.

Brent futures have moved into the largest and most sustained backwardation since June and July 2014, before the slump began and when the spot price was still trading above $100 per barrel.

The six-month calendar spread closed in a backwardation of $2.50 per barrel on Jan. 24, up from a contango of $1.85 twelve months ago.

Brent spreads regularly cycle between contango and backwardation as the global oil market alternates between periods of over- and under-supply.

Contango is associated with periods of high and rising stocks while backwardation is associated with low and falling inventories.

The current six-month spread is already in the 83rd percentile of the entire distribution from 1990 through 2018, a sign traders think stocks are tight and will tighten further.

Until recently, spreads in U.S. crude (WTI) lagged behind Brent, reflecting the high levels of stocks around the WTI contract’s delivery point at Cushing in Oklahoma.

But stocks at Cushing have drawn down sharply over the last two and a half months, from more than 64 million barrels to just 39 million barrels.

Cushing crude stocks are now 26 million barrels below the same point in 2017, according to an analysis of data from the U.S. Energy Information Administration (EIA).

Cushing stocks are less than 2 million barrels above the 10-year average, down from almost 30 million barrels over the seasonal average at the start of November.

Over the same period, the six-month WTI calendar spread has swung into a backwardation of more than $2.50, from a small contango 12 weeks ago, catching up with Brent.

Tightening stocks and spreads on U.S. crude have narrowed the discount between WTI and Brent spot prices to less than $5 per barrel from more than $7 late last year.


The drawdown in crude stocks at Cushing reflects a broader reduction in crude and products inventories across the OECD.

Commercial oil stocks remain more than 100 million barrels above the five-year average, which is still OPEC’s official target.

But given the growth in global consumption since 2013, the five-year average is almost certainly too low and would leave the market feeling exceptionally tight.

Global liquid fuels consumption is forecast to average more than 100 million barrels per day (b/d) in 2018, up from just 92 million b/d in 2013, according to the U.S. EIA.

OPEC ministers have signalled they want to draw down stock levels even further and intend to keep current production curbs in place through at least the end of 2018.

But the market already feels tight and if OPEC sticks to its current course is likely to tighten further, pushing spot prices and calendar spreads even higher.

Experience suggests OPEC normally tightens the market too much after a price slump and that spot prices and spreads will overshoot first before correcting later.

OPEC’s strategy and the movement in spot prices and spreads bears striking similarities with earlier episodes in 2000 and 2011 when prices shot well above the organisation’s initial targets.

Global oil consumption is growing strongly owing to synchronised growth in the major consuming economies and a cyclical acceleration in global industrial activity and freight movements.

If OPEC sticks to its current output levels, global crude and products stocks will feel very tight by the second half of 2018.

The market will respond by driving spot prices and spreads higher to encourage more production from shale producers and moderate demand growth.

Editing by David Evans

John Kemp is a Reuters market analyst. The views expressed are his own.

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