Front-month Brent prices are trading around $62 per barrel, down by more than $7.50 per barrel or 10% from the March 11 high. That is the sharpest fall since the first wave of the pandemic in April 2020.
For four months, prices had risen by more than $32 per barrel or 86%, boosted since November by progress on coronavirus vaccines.
The latest slide came during a resurgence of infections and slow progress with immunisations in a number of countries, including much of Europe, threatening resumption of international passenger air travel.
In retrospect, the futures market was already looking very overheated by the end of February and start of March, creating ideal conditions for a sharp retreat.
By the final trading day of February, front-month prices had risen by 30% in two months, a rate of increase in the 98th percentile for all similar periods since the start of 1993.
Brent’s six-month calendar spread had surged into a backwardation of more than $4.70 per barrel, also in the 98th percentile, pointing to a market expected to become exceptionally tight.
Futures prices on the last few trading days before contract expiry are often unrepresentative, so the outright and spread prices on Feb. 26 were mostly dismissed as an aberration.
But by March 5, with a new and more liquid front-month contract, prices remained up 25% over two months, and the backwardation was again above $4.20, both in the 96th percentile.
Futures prices were anticipating a strong and early recovery in demand, starting late in the second quarter and early in the third, as well as continued production restraint by OPEC+ and U.S. shale firms.
However, with Brent prices trading above $65, the inflow of additional speculative money into the market had effectively ceased several weeks earlier.
Hedge funds and other money managers effectively stopped buying extra crude futures and options contracts after Feb. 16, when front-month prices topped $63 for the first time in more than 13 months.
In the physical market, dated Brent spreads started to soften from Feb. 19, as the previous shortage of North Sea cargoes unwound, indicating the physical market was not as tight as futures prices implied.
The decision on March 4 by OPEC+ to leave output unchanged in April, rather than raise it as most market observers had expected, provided a final boost to prices.
But with spot prices and spreads already looking stretched, and no new speculative buying, the continued price rally was running on fumes and vulnerable to any less-than-bullish developments.
In this context, adverse news about coronavirus infections and the likely extension of international airline travel bans have proved enough to prompt a sharp drop in both spot prices and spreads.
The adjustment has likely been accelerated and exaggerated by portfolio managers’ position liquidation and profit-taking, just as the earlier rally was speeded up and magnified by their position building.
Prices and spreads now look less stretched than at the start of the month.
Provided front-month prices remain above about $55 and the six-month spread remains in backwardation, the recent fall in prices is likely to be seen as a temporary pull back in a longer-run cyclical upswing.
John Kemp is a Reuters market analyst. The views expressed are his own.