Oil market participants and analysts have been focused on the front-month oil futures prices that rallied to levels last seen in November 2014, with Brent Crude breaking above $80 a barrel last week.
Yet, over the past month, an even bigger rally has been taking place at the back end of the curve—in the five-year forward oil prices that generally trade in a much narrower band than front-month futures do.
The rally in forward prices has outpaced the front-month price increase, suggesting the speculators are betting on rising oil prices in the medium term, to 2022 and 2023, and that the ‘lower-for-longer’ could be over, analysts tell Bloomberg.
While Brent Crude jumped last week to above $80 and WTI Crude broke above $72, the five-year Brent forward price has jumped to above $63 a barrel, after having traded mostly constrained in the $55-60 narrow range for the past year and a half. Brent for December 2022 delivery has jumped by 10 percent since the beginning of May to more than $64 a barrel, and the December 2023 futures prices have surged past $63.
With oil producers not yet rushing to hedge production to the five-year forward price end of the curve and weighing down on prices, forward prices have more room to rise, analysts told Bloomberg.
The five-year forward Brent futures have jumped by 11 percent over the past month, while the front-month futures gained 6.8 percent.
Over the past few months, much of the rally in front-month futures prices has been driven by geopolitical concerns of possible supply disruptions in the short term, with plunging Venezuelan production and a potential loss of some Iranian oil barrels with the reintroduction of the U.S. sanctions on Tehran. Related: Farmers Reeling From High Oil Prices
In the five-year forward prices, speculators and analysts look at the longer-term forecasts for supply and demand that are more ‘shielded’ from the geopolitical risk premium that pushes the $80 oil rally we all see in the charts.
According to analysts and traders who spoke to Bloomberg, the forward price rally is more impressive than the front-month price gains and suggests that investors and speculators could be betting on higher oil prices in five years’ time based on supply and demand expectations.
“The war premium at the front of the market masked the fact that future significant demand increases and questions over supply levels equate to higher prices down the line,” Richard Fullarton, founder of commodity-focused hedge fund Matilda Capital Management, told Bloomberg.
On the demand side, global oil demand growth continues to be strong, following stronger-than-expected demand last year. The price rally has had some analysts question whether $80 oil could start slowing down some of the expected oil demand growth. Yet, currently growth is still expected to be strong.
On the supply side, the OPEC/non-OPEC cuts are currently holding back oil volumes from the market. Regardless of how long OPEC and friends will withhold 1.8 million bpd—due to Venezuela’s plunge it’s more than 2 million bpd—of supply, the oil industry will start to feel soon the underinvestment in projects during the worst of the oil price slump, analysts warn.
According to the International Energy Agency’s (IEA) Oil 2018 report, “the recovery from the historic drop-off in investments by 25 percent in both 2015 and 2016 has barely started. Investment was flat in 2017, and early data suggests only a modest rise in 2018. This is potentially storing up trouble for the future.” Related: How Does Oil Impact Bond Markets
Current investment is overwhelmingly taking place in U.S. shale, and “upstream investment may be inadequate to avoid a significant squeezing of the global spare capacity cushion by 2023, even as costs have fallen and project efficiency has improved,” the IEA said.
Five years from now, global oil demand is expected to continue to grow while supply could be squeezed by the 2015-2016 slump in investments in longer-lead time offshore projects.
Thus, the rally in five-year forward prices is not without its reasons.
“For the first time since December 2015, the back end of the curve has been leading the complex higher,” Yasser Elguindi, a market strategist at Energy Aspects Ltd in New York, told Bloomberg.
“It seems that the investor community is finally calling into question the ‘lower for longer’ thesis.”
By Tsvetana Paraskova for Oilprice.com
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That is why I have been projecting for a quite a while that oil prices are heading this year beyond $80 a barrel, rising to $85-$90 in 2019 and hitting $100 or higher in 2020.
The first and foremost factor underpinning the surge in oil prices is the positive fundamentals of the global oil market aided to some extent by rising geopolitical concerns which could boost oil prices by $1-$3 a barrel.
This brings us to two realizations. One is that OPEC members and Russia have now realized the great benefits they can reap by displaying true discipline in abiding by their production cut agreement. Selling an extra barrel above their production quota, say at $50 is no match to withholding one and selling it later at $90. The difference is the price of discipline and patience.
The second realization is that they are now learning to aim at maximizing the return on their finite assets to the highest level the global economy will allow them. This is a very sound economic principle. Another principle is to start without a minute’s delay to diversify their economies and not to be lulled by higher oil revenues.
This brings us to sentiments. When the global oil market feels that oil prices are buoyed by positive market fundamentals and discipline by major oil-producing nations, traders, analysts, banks and experts start to express positive sentiments in the market and oil prices and this growing psychological feeling starts to create a momentum of it own pushing prices up.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London