Steep Backwardation is Bullish for Oil Prices - Feb 15

[dan_s]

Oil prices hit critical threshold for OPEC+
in Oil & Companies News 15/02/2021
Source: Reuters (Editing by Jan Harvey)

Oil prices have reached a critical threshold where OPEC+ must decide whether to increase production, or risk losing market share again to U.S. shale producers.

Front-month Brent futures prices have climbed to more than $60 per barrel, up from less than $40 when the first successful vaccines were announced in November, and less than $20 when the pandemic was raging in April.

After adjusting for inflation, Brent prices are now in the 58th percentile for all months since the start of 1990, which is consistent with slow but steady increases in output by non-OPEC producers.

In the last decade, whenever Brent prices averaged more than about $57 per barrel, U.S. producers captured all the growth in global oil consumption, increasing their market share at the expense of OPEC and its allies.

Responding to the earlier rise in prices, U.S. producers have already increased the number of rigs drilling for oil to nearly 300, up from a low of just 172 in August, according to oilfield services company Baker Hughes.

More recent price increases are likely to ensure the number of active rigs increases at least until the end of June, when the count is likely to exceed 425 or even 450, if the current trend continues.

Reflecting the rising rig count, U.S. production from the Lower 48 states excluding the Gulf of Mexico is already forecast to rise from current levels by 340,000 barrels per day (bpd) by the end of 2021.

Further production gains of 640,000 bpd are expected by the end of 2022, according to the Energy Information Administration (“Short-term energy outlook”, EIA, Feb. 9).

If prices rise further, both drilling and production are likely to accelerate even faster in the second half of 2021 and 2022.

BACKWARDATION

In the futures market, the price for Brent delivered in April is trading more than $2.70 per barrel higher than for deliveries in November, a price structure known as backwardation.

Backwardation normally occurs when traders anticipate production will fall short of consumption and petroleum inventories are low and falling further.

The current degree of backwardation in the futures market is in the 85th percentile for all trading days since the start of 1990, and has been trending higher.

The implication is that traders anticipate a large production shortfall over the rest of this year, with inventories depleted below long-term average levels.

If that expectation proves correct, Brent prices are likely to increase further, perhaps significantly. Escalating prices and intensifying backwardation are both signalling the need for more production in the rest of the year.

Unless OPEC and its allies in OPEC+ provide the extra output to cover the shortfall, it will come from U.S. shale producers and other non-OPEC sources, encouraged by rising prices to boost output.

OPEC+ DECISION TIME

Between 2011 and the first half of 2014, and then again between 2017 and 2019, OPEC and then OPEC+ failed to increase output enough to relieve the anticipated shortage and ease upward pressure on prices.

In both instances, prices surged, the market moved into a large and sustained backwardation and, with a delay of 12-18 months, U.S. shale production surged higher.

Both times, OPEC insisted the market was not tight and there was no need to increase output – until it was too late and the surge in shale production had already pushed the market back into an incipient oversupply.

OPEC members harvested the windfall from higher prices and revenues, even as their market share eroded and shale production surged, creating conditions for an eventual slump.

OPEC’s delay in relieving the shortfall contributed to the explosive upswing in prices, worsening cyclical instability, and making the next cyclical downturn inevitable.

In March and April this year, OPEC+ will again face the same question about whether to increase production to pre-empt an unsustainable increase in prices.

Because of the delays between making a decision to raise output and extra barrels actually being available to consumers, OPEC+ must make a decision in the next six weeks to affect supply at the end of the second quarter and the start of the third, when the market is expected to become very tight.

The question is whether OPEC+ will postpone output increases, as it did in 2013/14 and again in 2017/18, or move proactively to relieve the pressure on supply and moderate the upward cycle in prices.

[dan_s]

News that China's imports of oil increased by 18% from December to January run contrary to IEA's forecast the oil demand in Asia was softening. In pre-market trading, WIT is up about $1 to $60.50/bbl.
Oil is trading higher in Asia:

TOKYO (Reuters) - Oil prices rose to their highest in more than a year on Monday, after a Saudi-led coalition fighting in Yemen said it intercepted an explosive-laden drone fired by the Iran-aligned Houthi group, raising fears of fresh Middle East tensions. MY TAKE: Iran will be testing Biden. There is also evidence that Iran is much closer to having weapons grade uranium. I pray that Team Biden does not go soft on Iran. This world depends on a steady flow of oil from the Middle East.

Hopes for more U.S. stimulus and an easing of coronavirus lockdowns helped support the rally, after prices gained around 5% last week.

Brent crude was up 66 cents, or 1.1%, at $63.09 a barrel at 0004 GMT, after climbing to a session high of $63.44, the highest since Jan. 22, 2020.

U.S. West Texas Intermediate (WTI) crude futures gained 86 cents, or 1.5%, to $60.33 a barrel. It touched the highest since Jan. 8 last year of $60.77 earlier in the session.

The Saudi-led coalition fighting in Yemen said late on Sunday it intercepted and destroyed an explosive-laden drone fired by the Iran-aligned Houthi group toward the kingdom, state TV reported.

"An early spike in oil markets was triggered by the news," said Kazuhiko Saito, chief analyst at commodities broker Fujitomi Co.

"But the rally was also driven by growing hopes that a U.S. stimulus and easing of lockdowns will boost the economy and fuel demand," he said. WTI may be pulled back by profit-taking as it reached a key $60 level, he added.

U.S. President Joe Biden pushed for the first major legislative achievement of his term on Friday, turning to a bipartisan group of local officials for help on his $1.9 trillion coronavirus relief plan.

Oil prices have rallied over recent weeks also as supplies tighten, due largely to production cuts from the Organization of the Petroleum Exporting Countries (OPEC) and allied producers in the group OPEC+.

[dan_s]

Holiday schedule for markets
On Monday, February 15, 2021, stock, options, and bond markets will be closed. Commodities Futures markets will close at 1 PM ET.