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OIL TRADERS EXPECT STOCKS TO FALL SIGNIFICANTLY AFTER OPEC EXTENDS CUTS

By John Kemp
March 22, 20241:59 AM GMT+1Updated 9 months ago
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A maze of crude oil pipes and valves is pictured during a tour by the Department
of Energy at the Strategic Petroleum Reserve in Freeport, Texas, U.S. June 9,
2016. REUTERS/Richard Carson/File Photo Purchase Licensing Rights, opens new tab
LONDON, March 21 (Reuters) - Global petroleum inventories are only slightly
below the long-term seasonal average but futures prices have already moved into
a steep backwardation as traders anticipate they will deplete further over the
rest of 2024.
OECD commercial inventories of crude oil and refined products are estimated to
have been around 75 million barrels (-3% or -0.48 standard deviations) below the
prior ten-year seasonal average at the end of February.
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The U.S. Energy Information Administration’s “Short-Term Energy Outlook, opens
new tab” shows the deficit has changed very little since March 2023 despite some
fairly significant swings in spot prices and calendar spreads.
Extra production cuts by Saudi Arabia and its OPEC⁺ allies have been offset by
faster-than-anticipated growth in non-OPEC output, mostly from the United
States, Canada, Brazil and Guyana.
Petroleum consumption has continued to increase steadily in line with its
long-term trend despite the prolonged slowdown in manufacturing and freight
activity across North America, Europe and China.
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SPOT VERSUS SPREAD

Front-month futures prices for the benchmark Brent contract have averaged around
$84 per barrel so far in March, almost exactly in line with the long-term
average since the start of the century, once inflation is taken into account.
Average front-month prices have risen modestly from the recent low of $78 per
barrel in December, which was in the 43rd percentile for all months since 2000
in real terms.

Nearly all the price increases have been concentrated in the contracts nearest
to delivery, with little or no change in prices for deliveries in 2025 and
beyond.
Calendar average futures prices for Brent delivered in equal instalments over
the course of 2025 have averaged $76 so far in March up only slightly from $74
in December.
Chartbook: Global petroleum inventories and prices, opens new tab
The relative increase in nearby futures prices has pushed the market structure
into an increasingly steep backwardation.

Front-month prices have traded at an average premium of almost $4 over contracts
for delivery six months later so far in March (91st percentile).
The six-month calendar spread has strengthened significantly from an average of
just 42 cents per barrel (43rd percentile) in December.


PRODUCTION RESTRAINT

Such a steep backwardation would normally be associated with inventories that
are already low and rapidly depleting. The rapid move would also normally be
associated by a larger increase in spot prices.

In this instance, however, traders seem to be anticipating a much larger
depletion of inventories over the rest of the year rather than any current
tightness in the market.
Traders are reacting to signals that Saudi Arabia and its OPEC+ allies will
extend their cuts through the middle of year and beyond, even if consumption
remains robust and inventories draw down significantly.
Price rises mostly in nearby contracts imply the market is responding to the
anticipated restriction of production rather than upgrades in the outlook for
the economy and consumption.
Saudi Arabia and its closest allies have accepted a smaller share of global
production to support prices at a higher level and this calculation is expected
to be maintained for the indefinite future.
Production cuts will only be reversed “subject to market conditions”, OPEC
announced on March 3, in other words when consumption is strong enough that
output can be increased without lowering prices.


REDUCING DOWNSIDE RISK

Saudi Arabia’s willingness to extend its voluntary production restraint has
removed much of the downside risk from oil prices despite uncertainty about the
outlook for the global economy and interest rates.
By March 12, hedge funds and other money managers have boosted their net
position in futures and options linked to Brent and U.S. crude to the equivalent
of 379 million barrels (27th percentile for all weeks since records began in
2013).
The combined position is still fairly low, and could be characterised as
moderately bearish overall, but it is lot more positive than in the middle of
December, when it fell to a record low of just 128 million barrels.
Bullish long positions outnumbered bearish short ones by a ratio of 3.58:1 (36th
percentile) up from just 1.47:1 (a record low) on December 12.
Portfolio investors remain cautious about prices increasing further, at least
until there are clearer signs of a recovery in industrial activity, but are no
longer so fearful of them declining again.
One way or another, however, the current contradiction between average spot
prices and a strong backwardation will have to be resolved.
If global inventories deplete as much as the strong backwardation implies, spot
prices are likely to rise over the course of the year and very likely to exceed
$90.
But if the market remains comfortably supplied, as the current level of spot
prices implies, the backwardation will gradually ease.
Related columns:
- Record U.S. oil and gas production keeps prices under pressure (March 1, 2024)
- Western Hemisphere oil output surges, with a helping hand from OPEC (February
21, 2024)
- Oil consumption and prices revert to trend (January 12, 2024)
John Kemp is a Reuters market analyst. The views expressed are his own. Follow
his commentary on X https://twitter.com/JKempEnergy, opens new tab

The Reuters Power Up newsletter provides everything you need to know about the
global energy industry. Sign up here.

Editing by Marguerita Choy

Our Standards: The Thomson Reuters Trust Principles., opens new tab

 * Suggested Topics:
 * Energy
 * Exploration & Production
 * OPEC
 * Storage
 * Gas

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Purchase Licensing Rights
John Kemp

Thomson Reuters

John Kemp is a senior market analyst specializing in oil and energy systems.
Before joining Reuters in 2008, he was a trading analyst at Sempra Commodities,
now part of JPMorgan, and an economic analyst at Oxford Analytica. His interests
include all aspects of energy technology, history, diplomacy, derivative
markets, risk management, policy and transitions.

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