Oil futures show no sign of market tightening despite OPEC talks: Kemp

OPEC reported to be discussing initial deal lasting six months, too short to have much impact on stock futures

By John Kemp

LONDON (Reuters) – If OPEC hopes to speed up the rebalancing of the oil market by announcing a production-limiting plan, someone should tell the futures market.

Front-month futures have risen sharply in recent days amid rising expectations OPEC will reach some sort of agreement by the next ministerial meeting on Nov. 30.

Front-month Brent is up by around $5 per barrel, or more than 10 percent, from its recent low on Nov. 14, amid positive chatter from oil ministers and officials.

Much of the rise in prices appears to be the result of a classic short-covering rally as hedge funds close out some of the large short positions they established over the previous three weeks.

But the sudden strengthening of spot prices is at odds with the continued weakness evident in the futures price curve.

The futures strip remains mired in contango and shows none of the strength that would indicate traders expect the market to tighten over the next six months.

The shape of the futures curve is usually closely related to traders’ expectations about physical oil production, consumption and inventories.

In the past, a tightening of the supply-demand balance and a drawdown in stocks have been accompanied by a gradual shift from contango to backwardation.

But the futures curve shows no sign of an expected drawdown in stockpiles this time around. In fact, the contango has been widening rather than narrowing consistently since the end of April.

If oil market rebalancing were expected over the next few months, the contango should be narrowing not widening.

And if an OPEC deal was expected to accelerate the process, the contango should be narrowing even more quickly.

Instead, the wide contango points to continued oversupply and no drawdown in stocks for the foreseeable future.

The contango for the first six futures months is actually now wider (around $3.90 per barrel) than at the time of the OPEC meeting in Sept. (around $2.70) when the outlines of a production deal were announced.

While OPEC ministers, oil analysts and hedge fund managers have been engaged in a high-stakes game of “Deal or No Deal”, the organisation’s output has been increasing, pushing back the rebalancing horizon.

OPEC production is now 0.64-1.14 million barrels per day above the target of 32.5-33.0 million barrels per day it outlined in Sept.

Extra production is going straight into inventories, postponing any inventory drawdown further into the future and making OPEC’s task harder.

Negotiators are reported to be discussing an initial deal lasting for just six months, which is too short to have much impact on stocks (“OPEC experts resume talks on oil output cut, delegates upbeat”, Reuters, Nov. 22).

The deal is likely to be characterised by OPEC as a first step but it would have to be extended later to have any material impact on the oil market balance and prices.

The deal would probably need to be extended for the second half of 2017 to make a dent in stockpiles.

If OPEC really can reach a agreement that changes the outlook for the supply-demand-stocks balance in a meaningful way, then it should show up in a big shift in the timespreads, and there is a big shift ahead.

For the moment, however, most traders are betting nothing much will change, whatever the outcome of the discussions.