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Editorial comment

According to headlines, traders believe they have encountered another important sign that the oil market is rebalancing. The six-month spread of WTI futures has moved from a state of ‘contango’ to one of ‘backwardation’.

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These two terms, which sound vaguely like medical conditions, refer to the fact that the market has moved from a state where the price of oil futures is higher than the current spot delivery price (contango), to one where the current spot delivery price is higher than the price of oil futures (backwardation). In less convoluted terms, backwardation is often taken as a sign of increased immediate demand. WTI’s transition into backwardation echoes a similar change seen in the Brent market earlier this year.

One of the key factors behind this change in the market is, of course, OPEC’s decision to implement production cuts from the beginning of this year. When taking into account the support of non-OPEC members, such as Russia, the group has managed to remove approximately 1.8 million bpd from the market – roughly 2% of global supply. Furthermore, whilst previous attempts at production cuts have been marred by cheating, a survey conducted by Reuters shows that this latest round of cuts is currently being met with 92% compliance. Recent months have seen additional cuts to output, including a 120 000 bpd drop in production in October when Iraqi forces took control of oilfields formerly controlled by Kurdish fighters. 2017 has also seen upwards pressure on oil prices from the demand side, with the year seeing some of the strongest global economic growth since the 2008 financial crisis.

These factors have led to the highest oil prices since mid-2015, with Brent reaching US$61/bbl at the end of October. Bjarne Schieldrop, chief commodities analyst at SEB was quoted in the Financial Times as saying: “Oil has always been a cyclical market and at the moment traders are realising they’re still living off just two things to meet rising demand: US shale and the legacy investments in fields made prior to the price crash in 2014”. He went on to add that “from 2019 the pipeline of supply could dry up pretty quickly and the industry – including US shale producers – are signalling they need these higher prices.”

For those concerned that OPEC might decide to call off the production cuts and flood the market with oil, Saudi Arabia’s Crown Prince Mohammed bin Salman expressed his country’s support for extending the cuts into 2018, “The Kingdom affirms its readiness to extend the production cut agreement, which proved its feasibility by rebalancing supply and demand.” So, whilst the upstream industry has broadly accepted that the ‘lower for longer’ environment is here to stay, it appears that positive trends are emerging both in the markets and out in the field. Whether the developments of recent months actually translate into a full-blown recovery is far from certain, but the industry has more reason to be optimistic than it’s had for a while.

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