By John Kemp
LONDON, March 8 Forget spot prices. The
truly remarkable story in the oil market is what is (not)
happening at the back end of the futures curve.
Front-month Brent futures prices have climbed almost $17 per
barrel (15.6 percent) since the start of the year. And prices
for oil delivered in December 2015? Well they have risen a whole
$3.35 (3.6 percent) (Chart 1).
Correlations between spot and deferred oil prices are at the
lowest for more than four years as the back end of the curve
fails to rally in line with nearby futures prices (Chart 2).
While spot Brent prices are back to the levels recorded in
the first half of 2011, prices for deferred contracts are
significantly lower than at the corresponding point last year.
Dec 2015 futures are trading around $96 compared with around
$105-109 at the height of last year's price crisis.
Nearby and deferred contracts have
become almost entirely disconnected. Nearby prices are being
driven by short-term supply disruptions and fears about
escalating tensions with Iran. In contrast, forward prices
remain anchored by estimates of the projected long-term marginal
cost of producing sufficient crude to meet demand.
It is not the first time spot and forward prices have
diverged in recent years.
Large disconnections occurred in 2005 and again in 2007 when
long-dated futures failed to rally as fast as the spot market.
Market participants were slow to recognise the rise in oil
prices was not just a temporary blip but reflected a step-change
in emerging market energy demand and escalating exploration and
production costs ("the end of cheap oil").
In 2009, another big disconnection occurred when spot prices
sank in the midst of recession, while the forward market was
supported by hopes of eventual recovery and the resumption of
The final set of disconnections were associated with the
spike and subsequent fall in spot prices during the first half
of 2011 caused by the Libyan revolt, which largely left forward
prices unchanged, as the market judged (correctly as it turned
out) that the interruption of exports would prove temporary.
Long-dated contracts are not necessarily a more accurate
forecast of where prices are heading in future.
In 2005, and again in 2007, the long-dated market was slow
to react to secular changes in the market, while nearby
contracts adapted much faster. In contrast, nearby contracts
over-reacted in both 2009 and 2011.
Long-dated contracts eventually fell into line with the spot
market in 2005 and 2007. But in 2009 and again in 2011 it was
the spot market that eventually converged back with forward
Observers are sharply divided about whether the current
divergence will be resolved by spot prices falling or long-dated
If the recent rise in spot prices is entirely attributable
to short term dislocations and a political risk premium, spot
prices should fall back towards the long-dated average once the
interruptions are solved and tensions either ease or are brought
to a head.
If the spot market is really reflecting a prolonged
supply-demand imbalance -- of which problems in South Sudan,
Yemen, Syria and Iran are merely the latest manifestation --
then it is long-dated prices which will have to catch up.
Developing this theme, several prominent analysts argue
there is good value in far-dated futures contracts, as their
prices must eventually rise to reflect the still escalating
costs of finding and producing oil in more challenging
environments such as ultra-deepwater, as well as securing access
to reserves in an era of rising resource nationalism and social
spending in countries with large undeveloped oil fields.
While that argument remains popular among analysts, there is
little sign of traction with investors, with forward prices
struggling to rally.
Almost all the extra interest from investors is in
short-term contracts, designed to capitalise on a short-term
price spike, rather than a sustained rising trend. The pattern
is distinct from 2008, when many investors were buying deferred
contracts as much as five or even eight years forward.
If prices are spiking again, it is a different sort of spike
to 2008, driven for the time being by (short-term) geopolitics
rather than (long-term) fears about supply scarcity.