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Oil futures curve raises doubts over Opec rally

Opec’s first supply cut in eight years looks set to earn the 13-member cartel an extra $5bn a month in revenues. The 15 per cent rally in oil prices since last Wednesday’s agreement looks like an impressive return from a marginal cut in output, even if the deal was months in the making.

Beyond the headline price reaction the market has thrown Opec a curve ball. Oil future contracts for delivery late next year and further in the future are not reacting quite as enthusiastically.

The so-called oil forward curve consists of dozens of individual monthly contracts stretching years into the future. Each one is for delivery on a specific date and when plotted on a graph gives an immediate snapshot of the market’s longer-term expectations.

Brent, the international benchmark, may have risen 15 per cent for delivery in the new year but the future contract for next December is only up 10 per cent. Further out the curve reaction has been even more muted, with December 2018 up only 6 per cent.

Historically, the curve has not always accurately predicted the oil price, however the reaction of later-dated contracts still highlights the challenge Opec faces. Oil producers, seeing prices jump after the agreement, have rushed to sell future output as a hedge against a downturn.

Partly this is good risk management and a natural reaction to two brutal years for the industry, which left many smaller producers — particularly in the US shale patch or those pursuing marginal fields in the North Sea — wondering if they could keep the lights on for another month.

But it also indicates that producers do not believe Opec has set oil on a one-way path to recovery. They would rather sell future output now to lock in a guaranteed price rather than gamble on oil marching higher.

It is a move that is more likely to please producers’ bankers than their shareholders. Beyond the steady dividend payments from the majors, for which they have had to borrow during the downturn, the reason for most investors to hold oil stocks is to get a degree of exposure to what remains the world’s most important commodity.

For Opec this aggressive producer hedging is also an early warning sign that many small oil companies are now profitable at not much above $55 a barrel after successfully cutting costs during the crash. The cartel will not have the market all its own way.

Companies selling Brent for December 2017 are doing so at about $56 a barrel. They are unlikely to do that if the price was not enough to cover their costs. In the US, the West Texas Intermediate benchmark contract for the same month, which is heavily used for hedging by shale producers, is at just $54 a barrel.

In light of the resilience shown by the US shale industry the US Energy Information Administration, the statistical arm of the Department of Energy, came close to announcing the end of the price-induced decline in US oil output this week.

US production fell 560,000 barrels a day this year to 8.9m b/d, the EIA said, allowing Opec to claim some success in its two-year attempt to squeeze out higher-cost producers.

Still, the EIA now forecasts that US oil production will only slip 80,000 b/d in 2017 -— a rounding error in the 97m b/d global market.

With US output expected to be essentially flat next year Opec will be reliant on rising demand and declines in production outside the US to help keep the market buoyant, alongside its own as-yet-untested-this-decade supply continence.

The oil curve may not all be bad news for Opec, however. As oil contracts for delivery today move back closer to alignment with contracts for next year it is a sign traders do see the market slowly tightening.

From September next year the price jumps between each Brent contract — a key indicator of how oversupplied traders see the market — narrows dramatically to less than 10 cents a month compared with 35-80 cents in the first half of 2017.

That should see traders draw down near-record oil inventories as it becomes more difficult to finance storage.

Opec will need to maintain supply discipline, probably beyond the initial six months agreed in last week’s deal, to keep pushing the market in that direction. If it does, we may still see $60 a barrel or higher return next year. But, at the moment, the oil curve suggests there are doubts.

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