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Oil – Deficit looming; USD 70/barrel by Jun 2017?

June 2016

June 27, 2016 | 15:05 | Dubai

Report by BoAML, Global Energy Weekly: Oil curve flip

Both Brent and WTI curves flipped into contango shortly after the oil market moved into surplus in 2014. Will these curves flip again as the market moves into deficit? OECD oil stocks are very high, so a flip into backwardation will take time. Yet, inventories may not need to normalize to prior five year averages for three key reasons.

  • First, oil demand globally grew at a rate of 1.9mn b/d in 2015 and 1.6mn b/d in 1Q16 compared to a 10 year average of 1.0 mn b/d. If this growth is sustained, stocks could drop quickly in days of forward demand cover.
  • Second, as Saudi’s spare capacity goes down, the market will need a higher level of stocks to smooth out future imbalances.
  • Third, BoAML sees YoY global oil production growth turning negative for the next six to eight quarters.

The oil curve flips as OECD crude stocks drop to 1.1bn bbl

Other than supply and demand, the report highlights that China will not offload its SPR as the market moves into deficit, so most of the crude to meet market demand will have to come out of OECD inventories. Also, as oil demand continues to strengthen, they expect forward oil selling by producers to continue. After all, most producers in North America remain largely unhedged for 2017. As per estimates, timespreads (1st – 12th month) should realize a positive value on average in 2017 if OECD crude stocks draw below 1,100 mn bbl. Given the expectations of a global deficit of 0.7 mn b/d next year, or 255 mn bbl (half crude/half product), one could expect to see a draw of 125 mn bbl in crude stocks in 2017, suggesting timespreads may flip into backwardation in 1H17.

As WTI approaches $60/bbl, backwardation could kick in

Another important question for markets is at which spot price level a curve flip would occur. In their view, backwardation may kick in as Brent or WTI front-month prices move to $60/bbl. Given recent productivity improvements, they would expect extensive forward selling by North American producers in the $55 to $60/bbl range. As a result, the recent tightening of Dec 16 vs. 17 and Dec 17 vs. 18 prices will likely continue over the next few months until this spread moves to +1/bbl over the course of 1H17. As such, BoAML’s end-of-2Q17 price target of $70/bbl implies that that Brent crude oil curve will have moved into backwardation by next year’s driving season.

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