09 June 2016, London — Global oil markets seem to have moved back into balance thanks to strong growth in fuel consumption and a series of large supply disruptions in major crude producing nations.
Motorists’ soaring consumption of cheap gasoline in the United States as well as in some large emerging economies, including India and Mexico, will help boost global oil demand by more than 1.4 million barrels per day in 2016.
Consumption had already risen by 1.8 million b/d in 2015 and is predicted to increase by well over 1.0 million b/d again next year, marking the strongest and most sustained increase in demand since before the financial crisis.
On the supply side, U.S. oil production is expected to fall by 700,000 b/d between 2015 and 2016 as lower prices curb onshore shale drilling.
And a lengthening list of supply disruptions from Libya, Nigeria, Venezuela and Canada among others has grown to more than 3 million b/d.
While stocks of crude and fuels remain unusually high following heavy oversupply in 2014 and 2015 they are no longer increasing.
The shift from oversupply to market balance is evident in the relationship between nearby and deferred futures prices.
The link between timespreads, consumption, production and inventories has been established since the 1930s and is closely watched by traders.
In general, periods of oversupply and increasing inventories are associated with a contango in futures prices, where the price for nearby contracts is lower than for those maturing later.
Excess demand and falling stocks are normally associated with backwardation, the opposite condition, where the price for nearby contracts is higher than for deferred dates.
Over the past 30 years, shifts in the market balance from oversupply to excess demand have normally been heralded by a change from contango to backwardation and vice versa.
In the last six months, the degree of contango in both Brent and WTI futures has shrunk significantly, consistent with signs of strong demand and faltering supply.
Both futures markets continue to trade in a small contango but that is consistent with a market very close to balance.
Since 2005, the “normal” condition in the crude oil market has been a small contango (between 1985 and 2004 the typical condition was a small backwardation and the reason for the shift is controversial).
Between 2005 and 2014, the first and seventh WTI contracts traded in contango more than 70 percent of the time (reversing the previous tendency to trade in backwardation more than 70 percent of the time).
The current contango in WTI prices at around $2.00 per barrel is not significantly different from the average contango of $1.50 per barrel between 2005 and 2014.
The current Brent contango at around $1.70 per barrel for the first six months is not far from the decade average of $0.73.
The risks to the supply-demand-price outlook now appear reasonably balanced which is being reflected in both spot prices and the timespreads.
On the supply side, crude production could surprise on the upside in the next 12 months if some of the current disruptions are resolved.
If Nigeria’s government can restore security in the delta, more than 0.5 million b/d of extra supply could return to market relatively quickly (“Militant attacks have cut Nigerian oil output by half a million b/d”, Reuters, Jun 6).
U.S. shale production could also stabilize and start to rise again if oil prices remain at or above the $50 per barrel level.
The number of rigs drilling for oil and gas in the United States rose last week for the first time in nine months, probably in response to the recent rise in prices.
But the bigger risk in the medium term comes from demand, which is now growing much faster than new sources of supply.
Investment in oil exploration and production have been slashed in response to the collapse in prices since the middle of 2014.
As the cycle turns, however, significant increases in investment will be needed to replace declining output from existing oil fields and meet the continued growth in consumption, which may require a further price increase.
By 2018, assuming the global economy avoid recession, higher prices will be needed to restrain super-fast growth in demand and incentivize quicker growth in supply.
*John Kepf; Editing – William Hardy – Reuters