Front-month Brent futures prices have risen by more than 20% over the last two months as fears about an Omicron-driven slowdown in consumption have been replaced by concern about the slow increase in production.
Brent’s six-month calendar spread has surged into a backwardation of more than $6 per barrel, which puts it in the 99th percentile for all trading days since 1990 ().
Put another way, Brent’s backwardation has only been more extreme on 80 out of the last 8,000 trading days, or in less than four months in the last 30 years.
The front-month futures contract for deliveries in March expires on Monday so it is not necessarily very representative anymore.
But the results do not change significantly if the analysis is shifted to the second-month contract for deliveries in April.
The combination of escalating spot prices and a rampaging backwardation is a classic signal the market is severely under-supplied.
By restricting output, Saudi Arabia and its allies in OPEC+ have drained all the excess inventories accumulated during the first wave of the epidemic and lockdowns in the second quarter of 2020.
At the same time, U.S. shale producers have transformed from insurgents, disruptors and revolutionaries into incumbents focused on limiting output growth, enjoying higher prices and maximising the return of cash to shareholders.
As a result, petroleum stocks in the United States and the other countries in the Organization for Economic Cooperation and Development have fallen well below the pre-pandemic five-year average for 2015-2019.
Global spare capacity is predicted to fall to less than 2 million barrels per day by the middle of the year according to private sector forecasters (“Oil market faces rocky road as shock absorbers wear thin”, Reuters, Jan. 27).
Global consumption is still growing rapidly as a result of the robust recovery from the pandemic-induced recession, with much of it focused on energy-intensive manufacturing and freight transport.
Into this tight market, the escalating confrontation between Russia and NATO has the potential to disrupt oil exports, while the easing of quarantines is likely to boost aviation-related consumption.
Prices are escalating to encourage faster production growth, force slower consumption growth, and rebuild inventories and spare capacity back to more comfortable levels.
Unless there is a relatively rapid production response, prices will continue rising until they weigh on business and consumer spending, or the increase in inflation draws a response from the major central banks.
Rising living costs and accelerating inflation have already forced their way up the agenda to become the top concern for households, businesses and policymakers in North America and Europe.
Petroleum-derived fuels are one of the largest and most visible items of expenditure for households and many businesses so the rise in oil prices is heightening anxiety about inflation more generally.
U.S. consumers have become gloomier about their own finances and the state of the economy than at any time since 2011, according to the University of Michigan’s monthly consumer survey in January.
The consumer sentiment index has fallen to just the 10th percentile for all months since 1980, down from a recent peak in the 47th percentile in April 2020.
“If something cannot go on forever it will stop,” said Herbert Stein, who had been U.S. President Richard Nixon’s chief economist, in 1986.
If oil prices continue escalating, the major consuming economies will eventually slow of their own accord or their central banks will be forced to raise interest rates sharply to bring inflation back under control.
John Kemp is a Reuters market analyst. The views expressed are his own.