There has been a change in the term structure of futures contracts since the OPEC production cut was finalized. In the last week, the maximum WTI near-term price has fallen $2.81 to $51.36 per barrel and prices do not reach $52 until mid-2021 (Figure 8).
Figure 8. The term structure of WTI futures contracts has changed. The maximum near-term forward price has fallen $2.81 per barrel in the last week. Source: CME and Labyrinth Consulting Services, Inc.
The term structure of Brent futures has changed also. Near-term forward prices have fallen $3.39 from a week ago to $53.15 per barrel then, fall into backwardation and do not reach $53 again until late in the third quarter of 2020 (Figure 9).
Figure 9. Figure 8. The term structure of Brent futures contracts has changed. The maximum near-term forward price has fallen $3.39 per barrel in the last week. Source: CME and Labyrinth Consulting Services, Inc.
Although the forward curve of futures contracts is hardly a predictor of oil prices, it appears that a major downward shift in oil prices is occurring. This reflects something far more consequential than a higher-than-expected U.S. crude oil storage report.
Overreaction or Turning Point?
In part, this week's price downturn reflects waning confidence that OPEC production cuts will result in higher prices. Much of the discussion until now has centered on whether OPEC will deliver on the announced cuts or if output increases by Libya and Nigeria will offset those cuts.
There seems to be a growing awareness that global oil markets are incredibly complex, and that there are so many moving parts that a single, simple solution is unlikely.
The problem may be about expectations. Many believe that the OPEC cuts will increase prices but the cuts may be more about establishing a floor under those prices.
There is no good reason why a normal addition to U.S. inventory should affect prices so much. The timing of this price adjustment may be an over-reaction but the direction may also represent a turning point.
The larger issue is the inexorable relationship between stocks and prices. It's not so much about this week's change in inventory. It's about how much inventory needs to be reduced and how long that will take in the most hopeful scenario.
If OECD stocks must fall by approximately 550 million barrels to support $70 prices, it will take more than a year to get there if production is cut by 1 mmb/d. If the production-consumption balance fluctuates, it will take even longer.
The change in the term structure of oil futures contracts suggests that causes for the recent price slump transcend oil market supply-demand fundamentals. Larger forces in the global economy are operating here. These may include reduced levels of credit creation that signal a slow-down in economic growth. If true, lower oil and other commodity prices are likely along with lower oil-demand growth.
For more than two years, the industry has believed that higher prices are possible without extreme reductions in inventories. Great expectations were placed in an OPEC production cut to rescue the industry from a weak oil market. The fallacy lies in thinking that the problem stems from a simple imbalance between production and consumption and is unrelated to a fragile and debt-dependent global economy.
That hope was a dream. It appears that oil markets have woken up from that dream.
Art Berman Petroleum Geologist and Professional Speaker Visit my website for more information: artberman.com
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Headline crude prices for the week beginning 16 September 2019 – Brent: US$69/b; WTI: US$63/b
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