For the past three years, the oil futures market has been stuck in a state of ‘contango’.
Contango is where the futures price of a commodity is higher than the spot price.
At present, there is a permanent state of contango in the oil markets, highlighted by the alarming amount of excess supply. After all, when there’s plenty of oil around, it tends to drive the price lower.
The Organization of the Petroleum Exporting Countries (OPEC) stepped in last year to support the oil price. The oil cartel wanted to reduce global oil production by two million barrels per day. Yet the ‘build a house on a handshake’ agreement was mostly ignored.
Given that lower oil prices are a concern for crude-producing countries, 21 OPEC and non-OPEC nations loosely agreed to reduce oil output. However, to date, only six of the members have reached the target number.
The oversupply in the marketplace has OPEC concerned, and they desperately want to ‘rebalance’ the market, reducing supply to boost the oil price.
Right now, the oil market is a dismal place for everyone in the supply chain. Since oil prices nosedived at the end of 2015, the commodity has traded as low as US$30 per barrel, struggling to maintain ground of US$50 a barrel.
Brent Crude price in US dollars
[Click to enlarge]
Adding to OPEC’s woes is a report from the International Energy Agency showing that inventories in major oil-producing countries could remain overflowing until after 2018. Meaning, without bigger cuts from OPEC, the oil market could remain oversupplied for more than a year.
Some Good News
However, there is some good news filtering through the market. In fact, according to colleague Greg Canavan’s recent analysis on the oil market, the oil supply glut may end much sooner than predicted.
Goldman Sachs reckons that the supply glut will end by the end of this year, claiming that there will be a shortage of more than 400 million barrels per day. Goldman noted a statement that ‘…the oil market has gone from nearing storage saturation to being in deficit much earlier than we expected.’ Adding that ‘sustained strong demand as well as sharply declining production’ will lead to a great shortage in the oil market.
However, the real excitement in the oil market is coming from the US. The US-based Energy Information Administration produces a weekly report summarising US oil inventories.
For the past seven weeks, US inventories have fallen. Over this time, the US has shed 43 million barrels, giving oil traders some hope the excess supply may be ending. Declining inventories are starting to show up in the futures market too, further boosting hopes that this ‘contango’ may be over shortly.
On Friday, oil futures jump 3% during US trading hours. Shrinking inventories played their part. But the key push behind the rise in futures prices came from a report that a major oil unit had been closed down. Apparently, oil giant Exxon Mobil Corporation [NYSE:XOM] shut down one of their units at a Texas refinery. This particular plant is the second largest refinery in the US. Closing down one of the units would significantly affect oil production at the plant, as it pumps out 584,000 barrels per day.
The final kicker for the futures price on Friday came from another report. The number of active rigs in the US dropped by five last week, leaving only 763 rigs active.
But the big determining factor for the oil price looking ahead will be what Saudi Arabia does next. Saudi Arabia has said it will reduce exports in August and September, further reducing how much oil they export to the US.
Should we believe them this time?
For the past three years, Saudi Arabia has had a habit of telling the market what it wants to hear. But things are different this time. Next year they plan to sell a 5% stake in the state-owned Saudi Aramco. The Saudis aren’t going to offer a portion of an oil-producing asset for rock-bottom prices.
Editor, Markets & Money