Oil mar­ket to move from re­bal­anc­ing to tight­en­ing

Kuwait Times - - Business -

LON­DON: The oil mar­ket is now well into a cycli­cal up­swing and within the next year the nar­ra­tive about “re­bal­anc­ing” is likely to be re­placed by one about “tight­en­ing”.

Re­bal­anc­ing started well be­fore the pro­duc­tion pact be­tween the Or­ga­ni­za­tion of the Petroleum Ex­port­ing Coun­tries (OPEC) and its al­lies went into ef­fect in Jan­uary. OPEC has been open about the fact that the re­bal­anc­ing process pre-dated its agree­ment, with of­fi­cials re­peat­edly not­ing the ac­cord was in­tended to “ac­cel­er­ate” a process that was al­ready un­der­way.

The spot price of Brent has been ris­ing since Jan­uary 2016 and the six-month cal­en­dar spread has been in­creas­ing since Jan­uary 2015. De­pend­ing on which turn­ing point is used, the re­bal­anc­ing process has al­ready been un­der­way for 21 months (spot prices) or 32 months (spreads).

Like any re­bal­anc­ing process, ad­just­ment is barely per­cep­ti­ble at first, which is why the turn­ing point is of­ten missed, but tends to ac­cel­er­ate over time. The cur­rent re­bal­anc­ing started with an ac­cel­er­a­tion in global oil con­sump­tion, which was al­ready ev­i­dent in the first half of 2015 in re­sponse to lower prices.

Oil pro­duc­tion did not de­cel­er­ate un­til 2016, be­cause of the lags in the sys­tem, and OPEC’s own out­put re­straint did not start un­til 2017. But with con­sump­tion now run­ning faster than pro­duc­tion the mar­ket is steadily whit­tling away the ex­cess in­ven­to­ries ac­cu­mu­lated in 2015/2016.

Dur­ing the last two re­bal­anc­ing pro­cesses, after oil slumps in 1998/99 and 2008/09, front-month Brent prices took roughly 21 months and 26 months re­spec­tively to reach their first major peak.

Mean­while, the cal­en­dar spread took 21 months and 34 months re­spec­tively to reach its first cycli­cal peak after each episode. The re­cent slump was in some ways deeper, and the re­cov­ery has cer­tainly been more pro­longed, but it can no longer be de­scribed as be­ing in its early stages.

The cur­rent re­bal­anc­ing process is al­ready there­fore fairly ma­ture and at some point in the next six to nine months will be more ac­cu­rately de­scribed as tight­en­ing.

The Brent spread has al­ready shifted de­ci­sively from con­tango to back­war­da­tion and is well within the up­per-half of its his­tor­i­cal range, point­ing to a mar­ket that is un­der­sup­plied and draw­ing down stocks. Ac­cord­ing es­ti­mates from the OPEC/non-OPEC Joint Min­is­te­rial Mon­i­tor­ing Com­mit­tee, OPEC is more than half­way to its de­clared tar­get of re­duc­ing OECD oil in­ven­to­ries to their five-year av­er­age.

Ex­cess stocks have been draw down by 180 mil­lion bar­rels since the start of 2017, al­though they are still 160 mil­lion bar­rels above the 2012-2016 av­er­age.

In prac­tice, stocks at the five-year av­er­age would prob­a­bly prove un­com­fort­ably low given the big in­crease in oil de­mand since 2012. Well be­fore the fiveyear av­er­age is reached, spot prices and spreads will rise to move the mar­ket from pro­duc­tion re­straint/con­sump­tion growth to pro­duc­tion growth/con­sump­tion re­straint.

In this con­text, the in­crease in front-month Brent fu­tures prices above $60 per bar­rel on Fri­day, for the first time since July 2015, and tight­en­ing of the cal­en­dar spread to its high­est on a sus­tained ba­sis since July 2014, is con­sis­tent with a mar­ket tran­si­tion­ing from re­bal­anc­ing to tight­en­ing. —Reuters

SAN ANSELMO: This file photo shows a cus­tomer pre­par­ing to pump gaso­line into his car at a gas sta­tion in San Anselmo, Cal­i­for­nia. —AFP

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