Oil Market Contango Returns In A Sign Of New Glut

Sluggish oil demand recovery with resurging coronavirus cases in many parts of the U.S. and the world and the return of previously withheld production from OPEC+ and North America have combined to flip the oil futures curve again to a sign of a new glut looming this year.

According to Reuters estimates, the Brent Crude futures for September 2020 have been trading lower than the futures contracts further out in time over the past week, which means the market is now back into contango—the state in which prices for delivery at later dates are higher than front-month prices.

During the peak lockdown period, when every major economy except China was under lockdown in late March and early April, the oil market was in a state of super contango. In this market situation, front-month prices were much lower than prices in future months, pointing to a crude oil oversupply and making storing oil for future sales profitable. Traders rushed to charter supertankers for floating storage for several months to a year so they could sell the oil at higher prices later.

In the middle of June, production cuts from OPEC+, economics-driven curtailments in the U.S. and Canada, and an uptick in oil demand helped the Brent Crude price structure flip to backwardation, signaling a tightening of the physical oil market.

At the end of June, backwardation was only seen for the next two to three months, but analysts expected the full Brent futures curve to be in backwardation by the end of the year thanks to recovering demand. Bank of America (BofA) Global Research, for example, expected that inventories in most regions would begin to draw down in the second half of this year, and the full Brent futures curve could flip by the end of the year to backwardation.

However, the recent resurgence of COVID-19 in many countries, including in the world’s top petroleum consumer, the United States, has had the oil market concerned about the trend in oil demand recovery.

In addition, OPEC+ is set to ease the record production cuts as of August 1, which will likely mean a new glut on the market, also because of slower-than-expected demand recovery, according to Rystad Energy.

“It is becoming more apparent that the demand recovery many were expecting in oil over the second half of the year was just too optimistic,” ING strategists Warren Patterson and Wenyu Yao said on Thursday.

“This suggests that we will see global supply starting to edge higher, and so given the disappointing demand, it raises the possibility that the market returns to building inventories in the months ahead, rather than drawing down stock, as initially assumed,” they said.