Opinion: Goldman Sachs takes on the Brent spreads

Goldman Sachs
Goldman Sachs says an extension of the OPEC supply cut deal would ultimately be self-defeating if it pushed prices up, causing a fast recovery in oil drilling. Getty Images photo.

Goldman Sachs says rebalancing of oil market “making progress”

By John Kemp

LONDON, March 28 (Reuters) – Progress towards oil-market rebalancing and the need for an extension of production cuts by OPEC and non-OPEC countries has become the most contentious issue in the oil market.

“We believe that the rebalancing of the oil market is in fact making progress despite the record high U.S. crude inventories,” Goldman Sachs analysts said in a note to clients on Sunday.

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Goldman expects oil stocks in the OECD to fall to the five-year average in terms of demand cover by the end of 2017, even if OPEC brings production back on line in the second half.

Goldman projects crude prices will move into backwardation and an extension of the cuts would exacerbate the feared shortfall in supplies. (“Data dependent OPEC unwise to let the stock draws run hot”, Goldman Sachs, March 26)

The bank says an extension would not be warranted and would ultimately be self-defeating if it pushed prices towards $65 per barrel and caused an even-faster recovery in oil drilling.

Goldman is one of the most influential banks in the oil market and among the hedge-fund community so the view of its respected research team carries considerable weight.

But the bank’s confidence in rebalancing during the second half of 2017 without an extension of the production deal puts it in a minority.

Most traders have become much less sure the market will enter a persistent period of undersupply with a sharp reduction in oil inventories.

Brent calendar spreads for the six months between June and December have weakened sharply over the last four weeks.

The calendar spread between June and December has shifted from a backwardation of 21 cents on Feb. 21 to a contango of 92 cents on March 27.

Contango is generally associated with a well-supplied market and high and/or increasing stocks, while backwardation is associated with an undersupplied market and low and/or falling stocks.

The calendar spread for the second half of 2017 is now trading at the widest contango since OPEC’s deal was announced on Nov. 30.

The weakening of the spreads has not been concentrated in any particular month, with price differentials easing for every month during the second half.

The spreads have become the prime battleground for hedge funds and other traders betting on the timing and speed of oil market rebalancing.

Brent and WTI spreads seem to have attracted heavy interest from some big players in the market at the end of 2016 and the first two months of 2017.

But after a selloff that started after Feb. 21, the current Brent futures price structure is in something of a no-man’s land.

Calendar spreads are barely wide enough to finance high levels of stocks through until the end of December but do not point to a fast draw down in stockpiles either.

From recent movements in the futures curve, many oil traders appear to believe the cuts need to be extended, and are unsure if that will happen, or if it will be enough.

If Goldman is right, however, the calendar spread for the second half of 2017 is currently undervalued and should strengthen significantly, so it presents a good buying opportunity.

If Goldman is wrong, and stocks remain high with or without an extension of the agreement, then most of the inter-month spreads are likely to weaken further as they near maturity to enable the stocks to be carried.

(Editing by Susan Fenton)

John Kemp is a Reuters market analyst. The views expressed are his own.