LONDON (Reuters) - Oil market rebalancing has decelerated over the last two months as producers’ output discipline shows signs of slackening and consumption recovers more slowly than anticipated at the start of the third quarter.
Members of the Organization of the Petroleum Exporting Countries (OPEC) and their partners in the broader exporters’ alliance (OPEC+) are showing signs of weakening commitment to output cuts agreed in April.
OPEC+ is consumed by arcane discussions about over-production by several countries for various reasons, the need for “compensating” output cuts in future, and requests for “exemptions”.
The production pact is following a familiar trajectory in which compliance starts to falter as the original sense of crisis that brought the agreement into being fades.
At the same time, consumption is not recovering as fast as anticipated three months ago, as the coronavirus epidemic continues and major economies are hit by job losses.
The global production-consumption balance, which was then expected to be in a significant deficit, with a large draw down in inventories, is now expected to remain in surplus, at least in the near-term.
The changing outlook for the production-consumption balance has been reflected in the calendar spreads for Brent in both the physical and futures markets.
Physical or dated Brent’s five-week spread slumped to a contango of -$0.64 per barrel on Sept. 2, down from a backwardation of +$1.05 cents on July 16.
Physical Brent’s calendar spread has fallen to the 20th percentile, down from the 88th on July 16, based on all trading days since the start of 2010.
On the futures side, Brent’s six-month calendar spread has slumped to a contango of -$2.29 from a contango of just -$0.48 on June 19.
The futures spread has fallen to the 20th percentile, down from the 38th percentile on June 19, indicating inventories are expected to remain high.
Betting prices will fall, some hedge funds and other money managers have boosted short positions in Brent futures and options to the equivalent of 84 million barrels from just 51 million at the end of June.
Hedge fund short positions have risen to the 64th percentile, up from the 21st percentile in June, based on trading days since 2013, as sentiment has turned increasingly negative.
Hedge funds’ bullish long positions still outnumber bearish short ones by a ratio of 3.47:1 but that has fallen from 5.22:1 at end-June.
(The long-short ratio has never fallen below 1.23:1 at any point since 2013, even during oil market downturns, illustrating the persistent long bias among portfolio investors).
Despite OPEC+ efforts to talk up compliance, market sentiment has deteriorated significantly, as investors become more sceptical about the pact’s ability to draw down inventories enough in the face of a long-lasting pandemic.
John Kemp is a Reuters market analyst. The views expressed are his own.
- U.S. oil inventories point to fragile recovery (Reuters, Aug. 21)
- Oil market sentiment softens as pandemic lingers (Reuters, Aug. 14)
- Oil prices no longer especially cheap after strong rally (Reuters, June 19)
Editing by Hugh Lawson
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