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Ron Bousso
Summary
- Brent oil prices drift towards $60 a barrel
- Future contracts have shifted in recent weeks into a contango structure
- Huge divergence in estimates over OPEC production to put floor on oil price decline
(Reuters) – Global oil prices are signalling that the market is tipping into a protracted period of oversupply, but the huge disparity in forecasts for OPEC’s production will likely limit the selloff.
Prompt Brent oil prices traded near $61 a barrel on Tuesday, the lowest since May. But, just as importantly, futures contracts for February delivery have started trading at a pronounced discount to future prices. That means the market is now in a so-called contango structure, suggesting that traders have finally started to accept the ultra-bearish forecasts for supply and demand in the coming year.
The International Energy Agency has for months warned that there will be a severe oil glut in 2025 and 2026, pointing to the ramp-up in production around the world, particularly from members of the OPEC+ alliance.
In the IEA’s latest report released last week, the Paris-based agency forecast a surplus of 2.35 million barrels per day in 2025 and 4 million bpd, or nearly 4% of global demand, next year.
Investors had until recently failed to price in the expected glut. That’s partly because OPEC analysts were, in contrast to the IEA, forecasting fairly balanced supply and demand this year and next. But it’s mostly because OECD inventories were at relatively low levels earlier in the year while demand was holding up in the face of U.S. President Donald Trump’s trade wars.
But that dynamic changed in August. Global observed inventories, which include supply from OECD countries and China as well as oil in transit at sea, hit a four-year high that month, having swollen by 225 million barrels from the start of the year, according to the IEA.
The rapid increase is largely due to China’s aggressive stockpiling since March, which continued in September, albeit at a slower rate. The fact that this build-up occurred in a part of the market where visibility is low helps explain the market caution.
THE OPEC ENIGMA
This downturn feels less durable than those in the past, however, because of the uncertainty regarding OPEC’s crude oil production. That’s a huge blind spot as the group accounted for nearly 30% of global supply last year.
The range of estimates for OPEC production has widened significantly since the start of the year, Morgan Stanley noted in a recent report covering seven major agencies and consultancies. This range expanded to 2.5 million bpd in September, or around 9% of the group’s production last month, after being negligible for years.
While the wide spread may reflect divergent projections for oil demand, it is likely driven largely by uncertainty over the pace of OPEC’s production increases this year following years of supply cuts.
Indeed, even OPEC itself appears unclear about its production. Kuwait’s oil minister last week said the organisation would appoint a “top” consultant to visit member states and assess their production capacity in the coming months.
SHADOW MARKET
The IEA supply and demand figures suggest the world will face a staggeringly large glut until 2027 with few historical precedents outside of the imbalance created by the abrupt collapse in global demand in the wake of the 2020 COVID lockdowns.
But things might not be quite so grim. History tells us that when prices drop and contango kicks in, oil producers rein in spending, particularly companies operating in the U.S. shale basins, where new wells have to be drilled constantly to maintain or grow output.
Indeed, with current U.S. oil prices around $57 a barrel, many shale drillers would already be unable to profitably drill new wells.
Of course, drilling activity has only modestly declined this year. The U.S. oil rig count has dropped by 13% to 418 since the start of the year to last week, according to energy services firm Baker Hughes. And the U.S. Energy Information Administration is still projecting to rise from a record 13.2 million bpd in 2024 to around 13.5 million bpd in 2025.
Moreover, major oil companies including Chevron and TotalEnergies may plan to reduce spending in the face of lower prices, but the sector does not appear to be retrenching, suggesting boards do not expect a prolonged downturn.
But what might keep crude prices from falling too far is one of the causes of the recent volatility: the increasing opacity in large swathes of the oil market.
Analysing crude flows has become increasingly difficult in recent years. Western sanctions on Russia’s oil industry have led to the development of a large shadow market that is often hard to track. And the lack of official data on China’s stockpiling has only further complicated things.
This challenge was laid bare in the IEA’s latest monthly report when it said it could not account for the whereabouts of 1.47 million bpd of crude.
This opacity combined with the lack of certainty about the production levels of the world’s largest oil-producing cartel is creating a major challenge for investors.
Until data is unequivocally pointing toward a large build-up in oil inventories, traders will likely be wary of making any more big moves, which could keep a floor under oil prices.
The opinions expressed here are those of the author, a columnist for Reuters.
Ron Bousso. Editing by Mark Potter
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