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Tsvetana Paraskova

Tsvetana Paraskova

Tsvetana is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing for news outlets such as iNVEZZ and…

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As OPEC Compliance Peaks, Can The Drawdowns Continue?

OPEC

Since it agreed to production cuts, OPEC stated that its mission is to see the oil futures curve flip from contango to backwardation as part of its work to erase the global oil glut. Since summer began, the contango is disappearing, and now Brent and Oman futures are in a state of backwardation for the rest of 2017 and for 2018, but OPEC’s work is far from over.    

Contango, a market situation in which the spot prices are lower than future prices, encourages traders to store crude oil and profit from selling it at prices higher than the spot market. Crude oil stores are precisely what OPEC is trying to do away with. Backwardation, contango’s opposite, was one of OPEC’s key goals with the output cuts—discouraging the storage of crude oil and driving oversupply down.

It looks like OPEC has accomplished one of its goals: flipping from contango to backwardation. Global inventories have dropped lately, and to further boost sentiment, global oil demand growth is strong expected to remain so for the year.  

But as we exit the peak demand summer months and enter the months leading to OPEC’s end-November meeting, OPEC’s current victory lap—that it constantly reminds the public of—may look a bit premature. Will the drawdown continue at a pace sufficient to eliminate oversupply and boost oil prices? The jury is out, and speculation’s rising about what OPEC would or should do after the production cut deal expires after its current deadline in March 2018. Related: Can Oil Prices Hit $60 In 2018?

Currently, the Brent and Oman futures contracts are trading in backwardation for 2017 and 2018, while the WTI futures curve is still in contango, albeit a narrower one than before the cuts took effect, Reuters columnist John Kemp writes.

Last week, OPEC praised itself for achieving the highest compliance rate since the cuts began. While the market has stopped reacting to the conformity levels the cartel is boasting, OPEC noted that commercial oil stocks have reduced at a fast pace.  

“Commercial oil stocks in the OECD fell further in August and the difference to the latest five-year average has been reduced by 168 million barrels since the beginning of this year; however, there remains another 170 million barrels of stock overhang to be depleted. Supported by the improving forward structure in the futures market, floating storage has also been on a declining trend since June,” OPEC said.

As in previous statements, the cartel continues its refrain: All options are still on the table.

In his opening remarks at Friday’s meeting of the OPEC/non-OPEC panel that is supervising the cuts, Kuwait’s Oil Minister HE Issam Almarzooq said:

“We have also witnessed a distinct change in the market structure over the past couple of months, initially with a narrowing contango and more recently when Brent flipped into backwardation. This we believe is a sign of the shrinking stockpiles, as well as stronger demand.”

Earlier this month, the International Energy Agency (IEA) noted that global oil demand grew very strongly year-on-year in the second quarter and revised up its forecast for oil demand growth for 2017 to 1.6 million bpd from 1.5 million bpd.   

Currently, not only is demand growth seen as strong, but the futures curve and OPEC’s cuts are also leading to a tighter market, and traders are said to be selling crude that they had stockpiled at Saldanha Bay in South Africa. Total, Vitol Group, and Mercuria Energy Group have started emptying storage, Bloomberg reports, citing people familiar with the matter.

“Backwardation is going to increase a bit,” Mercuria’s CEO Marco Dunand told Bloomberg in a recent interview.

Related: Expect A Major Leap In U.S. Oil Exports

“We are seeing a reduction in global inventories, although we can see another build-up in the first quarter of next year,” Dunand noted.

The first quarter of 2018 is the last quarter in which OPEC’s cuts would be in effect, if the cartel doesn’t extend or deepen production reductions. At that time of the season, demand is lower than in the summer, and ending the cuts in March—ahead of peak demand—could exacerbate the glut that OPEC and friends have been fighting this year.

By Tsvetana Paraskova for Oilprice.com

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