December 1, 2016 / 11:16 PM / 3 years ago

Red-letter day for oil spreads, as market now sees 2017 rebalancing

NEW YORK (Reuters) - After OPEC’s first output cut in eight years, long-dated oil futures spreads flipped into positive territory for the first time in two years on Thursday, suggesting an end to the global crude glut is in sight.

The tell can be found in a trade known as “Dec Red” - the spread between the December 2017 and 2018 U.S. crude futures contracts CLZ7-Z8.

That trade, a popular one in oil markets, flipped on Thursday for the first time since October 2014, as the 2017 contract is now trading at a higher price than the 2018 contract. The “red” term is one used to refer to a same-dated contract one year in the future.

This is known as backwardation - when later-dated contracts are cheaper than near-term contracts. It is a signal that traders expect bloated inventories in storage around the world may start to rapidly draw down, after years of oversupply that cut oil prices in half since mid-2014.

On Thursday, the Dec 2017 contract settled at $54.17 a barrel, compared with the Dec 2018 contract settled at $53.98, a 19-cent difference. Just two weeks ago, this spread was at $2 in contango, where later-dated contracts are more expensive than near term.

The 2018/2019 spread tightened by as much as 77 cents, though it remains in backwardation.

“It means that the market is perceiving that barrels need to come out of storage to balance the market,” said John Saucer, vice president of research and analysis at Mobius Risk Group in Houston. He expects inventories to stop building, which will be followed by draws.

For Brent, the Dec Red LCOZ7-Z8 spread narrowed to as little as 11 cents a barrel, though it remains in contango. Just two weeks ago, the later-dated contract was $2.64 higher. In 2018/2019 LCOZ8-Z9 it tightened by more than $1.

The bullish move comes just after Wednesday’s decision by the Organization of the Petroleum Exporting Countries to cap output by reducing production by around 1.2 million barrels per day.

The change in the market structure appears to align with OPEC’s desire to clear the overhang.

“Clearly, it doesn’t pay you to hold inventory and that’s what OPEC really wants,” Saucer said.

Goldman Sachs analysts on Wednesday said they see further upside to U.S. crude prices as the oil market shifts into a deficit through the first half of 2017.

According to the most recent data from the U.S. government, inventories stand at 141 million barrels higher than 2014.

But traders warned that the moves in the back of the curve could be short-lived, as much of the move was driven by speculative positions, rather than consumers.

That would undermine a sustainable recovery as additional barrels that are uneconomical to be held in storage tanks could re-enter and pressure the market, according to Michael Tran, director of energy strategy at RBC Capital Markets in New York.

Reporting by Catherine Ngai; Editing by Lisa Shumaker

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