Oil traders no longer expect the market to be oversupplied this year, amid optimism a full-blown U.S.-China trade war will be averted, and oil production growth will slow thanks to OPEC cuts and sanctions on Venezuela.
Front-month Brent futures prices have jumped to almost $65 per barrel, up from just $50 in late December, and the highest for nearly three months.
Brent’s six-month calendar spread has swung into a backwardation of almost 70 cents per barrel, from a contango of more than $1.50 late last year, the strongest for almost four months.
Crude prices and spreads are being propelled higher by an almost perfect storm of increasing economic optimism (or at least reducing pessimism), OPEC cuts and unplanned supply disruptions.
In recent days, senior policy-makers from both the United States and China have signalled trade negotiations are making good progress, as fear of recession makes both sides more eager for a deal.
More importantly, the U.S. president has indicated the deadline for the next round of tariff increases could be extended based on recent progress even if not all issues have been resolved by March 1.
Oil consumption growth is likely to slow this year from the very rapid rates reported between 2014 and 2017 but if tariff increases can be avoided oil use should continue increasing at a moderate pace.
Meanwhile, Saudi Arabia and its closest allies in OPEC have also acted early and aggressively to reduce production which should help eliminate the incipient surplus in the market.
Saudi Arabia’s oil minister has said the kingdom’s production will fall to just 9.8 million barrels per day in March from 11.1 million in November (“Saudi Arabia goes on hunt for global oil and gas,” Financial Times, Feb. 12).
Saudi Arabia’s willingness to act as swing producer has more than offset the limited cuts made by other members of the organization and its allies led by Russia.
The kingdom has demonstrated its commitment to eliminating the market surplus and pushing prices higher, even if it means tolerating poor compliance by other members of the OPEC+ group.
At the same time, Iran’s exports remain crimped by U.S. sanctions imposed in November, with the expectation they will be lowered further from May, when sanctions waivers are likely to become less generous.
And U.S. sanctions on Venezuela’s state-owned oil company PDVSA have reduced the country’s crude exports and tightened the global oil market even further.
U.S. policy-makers probably expected the Venezuela sanctions would have little impact on global production since they were expected to result in the rapid removal of President Nicolas Maduro.
But with the Maduro administration digging in for a long confrontation, traders have been forced to reappraise the possibility of a long disruption of exports that could last weeks or even months.
Production and consumption risks, concentrated on the downside at the start of the year, have therefore shifted to the upside in recent weeks.
Hedge fund positioning could accelerate the rise in prices and shift to backwardation.
Hedge funds and other money managers held an overall bullish position in Brent futures and options equivalent to just 234 million barrels at the start of February down from almost 500 million at the end of September.
Portfolio managers’ overall bullish position has already risen by nearly 100 million barrels over the last nine weeks but remains close to the lowest level for the last three years.
Funds hold just 5 long bullish contracts for every short bullish one, down from a ratio of almost 20:1 just over four months ago, so there is scope for more fund buying.
Production and consumption fundamentals as well as hedge fund positioning all suggest the balance of risks in oil has shifted to the upside, but only if trade talks are successful or extended, and recession is avoided.