Brent structure may weigh on spot prices, strategy

OREANDA-NEWS. April 15, 2016. A rare backwardation in the June-July North Sea forward spread could weigh on global spot markets and buying interest for long-distance cargoes if the international oil benchmark slides further toward backwardation.

North Sea maintenance and tightening supplies spurred the Argus June North Sea price to settle a more than \\$40/bl again, closing at \\$44.34/bl today — or 3?/bl above July North Sea. June hovered at just below parity to July throughout the week.

Beyond July, Argus North Sea is in contango at about 30?/bl, but it still reflects a shallower curve compared with an average 70?/bl contango spread between second and third month forward assessments last month.

If the structure were to move into backwardation beyond prompt month, it would mean long-haul crude cargoes would decrease in value before reaching their destination. Buyers would begin to offset the decreasing outright price expectation with a lower initial bid. Spot differentials to benchmarks on some Latin American and west African cargoes are already showing signs of hesitation by buyers.

Falling May production in the North Sea is pushing loading programs for 12 crude grades down by 7pc compared with April, a trend expected to continue through June and July. May loadings of the 12 crudes will average 1.91mn b/d, falling from an average of 2.07mn b/d in April.

Venezuela said that up to 20 countries covering 75pc of global oil production will meet in Doha, Qatar, on 17 April to discuss a coordinated approach to crude output control. The president of Russia's state-controlled Rosneft suggested the market oversupply is likely to be eliminated within two years amid an expected growth in demand and lower investments.

The US Energy Information Administration (EIA) subsequently predicted a 1.2mn b/d drop in US production by 2017, encouraging the growing belief that global supply imbalance is "rapidly" being corrected.

North Sea shipments east show signs of slowing, while west African production looks likely to be shorter during the summer as well. Nigerian Forcados is still shut in from a months-long force majeure with no anticipated end date.

Decreasing buying interest is already evident in the west African market as some April volumes of Qua Iboe are still thought to be available, and spot price differentials to benchmarks on prompt May cargoes are considerably lower than end-month cargoes.

Companies are likely to begin withdrawing inventories to minimize the opportunity cost of storing crude. Storage strategies are unattractive in a backwardated market as crude is expected to lose value over time, so refiners would be expected to run inventories before considering further spot purchases. And trading firms that participate in storage would need to reassess profit-maximizing strategies.

The last time forward North Sea months remained below prompt values for a period longer than two days was from April 2014 to July 2014 after only a week of being in contango. The move to a contango structure in mid-July also marked the highest settlement prices seen since that day as global crude prices began an ongoing downward trend.