LONDON, Jan 28 (Reuters) - Oil prices are showing signs of
overheating as traders anticipate a severe shortage of petroleum
this year: inventories are already low and there is little spare
capacity to raise production in the short term.
Spot prices are climbing rapidly and the futures market has
moved into one of the most extreme backwardations in the last
three decades, a classic signal the market is expected to become
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slowdown in consumption have been replaced by concern about the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.
Brents 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 (https://tmsnrt.rs/3g7Qfxo).
Put another way, Brents 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
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
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
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
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
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
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
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 Michigans 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 Nixons 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.
- Commodity prices likely to be hit by slowdown before end
- Shrunken U.S. oil inventories point to chronic
under-supply (Reuters, Jan. 21)
- Escalating U.S. inflation forces macro policy rethink
- Global economy faces biggest headwind from inflation
(Reuters, Oct. 14)
John Kemp is a Reuters market analyst. The views expressed
are his own
(Editing by Louise Heavens)