© Reuters. FILE PHOTO: Oil pump jacks are seen at the Vaca Muerta shale oil and gas deposit in Argentina’s Neuquen Patagonia province on January 21, 2019. REUTERS/Agustin Marcarian
By: Alex Lawler, Julia Payne and Stephanie Kelly
LONDON/NEW YORK (Reuters) – Benchmark oil prices have fallen by around $15 a barrel over the past 10 days as the threat of a recession hangs over the demand outlook, but physical oil trading and the structure of the futures market tell a very different story .
Growing concerns about the economic outlook last week fell below $100 a barrel for the first time since April.
But in the physical market, premiums have been at record levels. This week, Nigeria’s Qua Iboe crude was offered $11.50 a barrel above Brent, while North Sea-grade Forties was offered at an all-time high of $5.35 plus obsolete Brent on Tuesday.
While Brent crude prices have fallen nearly 20% since May, the premium for the near-term contract to a second month – a structure known as a backwardation, which means an immediate supply crunch – has widened to $4.09 a barrel.
This suggests that there is strong underlying support for short-term prices despite the decline in the benchmark Brent contract.
“Direct prices and structure are out of sync,” said Tamas Varga of oil broker PVM. “This means that the real strength in the physical side runs counter to the sentiment in the futures market.”
To help keep supplies tight, power outages have reduced output in Libya and Nigeria, Western sanctions are forcing Russia to rearrange oil flows, and OPEC and its allies have been unable to deliver on promised output increases.
“While a deep recession cannot be ignored, we remain focused on the objective fact that markets are actually tightening,” BCA Research said in a note. This “will keep oil markets volatile and skewed to the upside,” it said.
In the US, WTI-Midland and WTI in East Houston traded at a premium of more than $3 over futures in June, the highest level in more than two years.
Although both grades have since retreated from their highs, they are still trading more than 60% higher than they were at the start of June.
According to the U.S. Energy Information Administration, U.S. crude oil inventories were about 427.1 million barrels, down about 2.4 percent from the same period last year.
But while the market tightening is “certainly talking about”, in the words of one European trader, the risk of a recession remains high.
Varga said tightening “could also imply further upside potential; however, stubbornly high global inflation and its impact on oil demand may just turn a ‘buy the dip’ attitude into a ‘sell the dip’.”