In early July, there was a shift in the ICE Brent crude futures market — the backwardation that market players had become accustomed to flipped into contango. Some even said the market “collapsed” into a “supercontango” in a way not seen since 2008.
A contango market suggests ample supply in the prompt market, as the futures price of a commodity is above the expected future spot price. The contango in the Brent curve seems to suggest fatigue in oil demand, some say.
The front/second month spread for ICE Brent flipped into a 12 cents/barrel contango on July 8. By July 19 — the day of the August Brent contract expiration — the contango widened sharply to $1.30/b. But since then, the front/second month contango has steadied into a range between 11-49 cents/b.
What a difference the expiration of one futures contract can make. What seemed like a structural move into super contango for Brent about a week ago, with the first six contracts moving into contango on July 16, disappeared swiftly once the August Brent contract went off the board, noted analysts Amrita Sen and Richard Mallinson of Energy Aspects.
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After September Brent become the prompt month, all but the front two months are back in backwardation.
“Part of the recovery relates to that the market always look worse when it is at the bottom and positioning had resulted in prices shooting to the downside,” the analysts said. “In other words, the downward pressure that in some cases took spreads back to 2008/09 recession levels, was overdone.”
But does that mean this contango is not meant to last? The market is not out of the woods yet, Sen and Mallinson said.
“There are still a considerable number of cargoes left to clear in both West Africa and the North Sea and while the process has begun, it is starting to weigh on non-Atlantic crude grades,” they said.
For instance, as Asian refineries turn to Atlantic Basin crude in the process of bargain hunting, Middle Eastern crudes have started to weaken, with both Murban and al Shaheen grades at their weakest levels in over three years. Similarly, Hibernia crude fell to a discount to Dated Brent for the first time since 2010.
“So clearly, refineries are yet to raise runs sufficiently to absorb the current crude overhang,” Sen and Mallinson said.
Things are heading in the right direction but the overhang will still take a few weeks to clear.
Analysts at Bank of America Merrill Lynch said amid the contango, floating storage has come back into play.
“We believe this is an unusual market development that will not last,” they said.
History shows that when Brent flips from backwardation into contango, it tends to spend an average of 36 days in contango and tends to impact other markets like WTI, BoAML analysts noted.
For its structure, the front/second month NYMEX crude curve remains backwardated, rising to $2.03/b on July 22.
Barclays analysts expect the contango on the September-October Brent contract to narrow. Demand/supply factors, along with a multitude of geopolitical risks, continue to point to a constructive Q3 for the oil markets, they said.
In the meantime, we will check back in about 25 days to see if the Brent contango was meant to last, or just a repeat of history leading to a swift flip to good old backwardation.