Flip in Brent structure points to drop in oil stocks

By Jane Merriman - Analysis

LONDON (Reuters) - Brent oil futures have shifted into backwardation, a market condition that points to expectations of a tighter supply/demand picture that could shrink plentiful crude stocks.

The return of backwardation -- where crude for nearby delivery costs more than crude further forward -- could provide a signal for OPEC that crude oil supplies are no longer as abundant, potentially paving the way for a production increase.

"With backwardation, the market is starting to price in a very large crude oil draw," said Olivier Jakob, of oil consultants Petromatrix.

"I think OPEC is waiting to see if those big draws materialize or not."

These supply concerns helped on July 16 to drive Brent crude to within 25 cents of its record high of $78.65 a barrel.

The backwardation may not last, but while it does it removes a financial incentive to store oil.

"The important thing is that the storage play doesn't work any more," said Paul Horsnell, head of commodities research at Barclays Capital. "You can no longer lock in money by holding crude in inventory for trading purposes."

The September Brent futures contract is currently about 30 cents higher than October.

Brent moved into backwardation late last week from the opposite structure known as contango, where oil available for nearby delivery is cheaper than oil available further forward.

Brent was in backwardation from the end of 1998 to November 2004 when it moved into contango, according to Reuters data. It has stayed in contango apart from brief blips into backwardation in July/August 2006 and in January and March/April 2007.

U.S. crude futures have also been in contango, reflecting a glut of oil at Cushing, Oklahoma, the delivery point for crude oil futures contracts traded on the New York Mercantile Exchange.

But the U.S. crude forward price curve has also moved into backwardation.

"For a long time the highest point of the U.S. curve has been somewhere around early 2009," said Horsnell. "And now August is $2 above March 2009."

High prices have prompted consuming countries to urge the Organization of the Petroleum Exporting Countries to increase production. OPEC has resisted these demands, saying there is plenty of oil.

But if backwardation stays, it will shrink the supplies held in storage when it made economic sense to keep them there.