Crude oil traders are betting the market will tighten significantly next year, even as the major statistical agencies predict production will outstrip consumption and oil inventories will rise.
Most of the divergence can be explained by differing assumptions about global growth in 2020.
The International Energy Agency (IEA), the U.S. Energy Information Administration (EIA) and the Organization of the Petroleum Exporting Countries are all projecting that the oil market will be in surplus in 2020.
Each of the three agencies is forecasting that non-OPEC oil supplies will increase around 1 million barrels per day (bpd) faster than global oil consumption next year.
The three agencies are also forecasting non-OPEC production growth of 2.2-2.4 million bpd while consumption increases by only 1.1-1.4 million bpd.
If these forecasts are correct, the result will be a significant rise in stocks of crude and refined products, unless OPEC members and their allies reduce their own output even further.
But the shape of the crude futures curve suggests traders and hedge funds are instead anticipating a drawdown in stockpiles next year.
Brent’s six-month calendar spread has tightened to a backwardation of around $3.50 per barrel, up from less than $1.90 at the same a month ago and a contango of $1.10 this time last year.
Backwardation (where spot prices trade above futures prices) is normally associated with low/falling inventories, while contango (spot prices trading below futures) is typically associated with high/rising stockpiles.
The six-month calendar spread is now in the 91st percentile for all trading days since the start of 1990, implying that traders anticipate production will fall significantly below consumption over the next six months.
Brent futures have been progressively shifting towards backwardation since early 2015 as the crude market has gradually recovered from the slump of 2014/15.
But the current degree of backwardation is unusual: previous backwardations of similar magnitude have recently been temporary and associated with sudden disruptions in oil supplies.
Big backwardations have been caused by the attacks on Saudi Arabias oil installations in 2019 or the repeated tightening of U.S. sanctions on Venezuela and Iran in 2018.
The current backwardation, however, is not associated with any sudden loss of oil supplies. Instead it reflects the combination of steadily tightening supplies and expectations for faster demand growth in 2020.
U.S. sanctions continue to limit exports from Iran and Venezuela. Lower prices are expected to slow growth from U.S. shale. And the OPEC+ group of exporters is likely to extend current production restraints well into next year.
At the same time, investors and commodity traders are growing more hopeful the global economy will avoid a recession in 2020, which would support faster growth in oil consumption over the next 12-18 months.
Recent financial market and industrial data suggests the current cyclical downswing in the global economy may have past its worst point (Global economy dodges recession by the narrowest of margins, Reuters, Nov. 19).
If that proves correct, there is potential for a cyclical upswing in 2020/21, similar to the recovery in 1999/2000, after a similar mid-cycle slowdown in 1997/98 (Oil and equities prepare to party like its 1999, Reuters, March 19).
In the last two decades, oil consumption has grown on average by around 1.5 percent per year which at the moment is equivalent to an additional 1.5 million bpd per year.
If oil consumption growth returns to its long-term trend rate next year, consumption could rise by an extra 150,000 to 300,000 bpd compared with the current major-agency forecasts.
And if consumption rebounds more strongly like 1999, when it rose by 2.1 percent, oil use could increase by an extra 700,000 to 1 million bpd compared with the major forecasts.
A cyclical recovery in oil consumption could therefore absorb much of the predicted growth in non-OPEC production next year.
The resolution of US/China trade tensions, or at least a temporary truce, and the resulting impact on global growth, is therefore critical for the oil market balance and prices in 2020.
At the moment, most major economic forecasters, including the International Monetary Fund (IMF) and the Organisation for Economic Cooperation and Development (OECD) and see global growth staying subdued in 2020.
But if the US/China trade dispute can be resolved, and if the global expansion re-accelerates, there is the potential for faster growth in both economic activity and oil consumption.
Following the IMF/OECD, the major oil statistical agencies are predicting only a modest acceleration in global economic growth next year, implying the oil market will be oversupplied.
By contrast, oil traders are increasingly betting on a faster economic acceleration, eliminating the predicted oil surplus and even pushing the market into deficit.
At the moment, most hedge funds and other money managers have relatively small speculative positions in petroleum futures and options betting on an increase in prices.
If the prospect of a cyclical recovery encourages more fund managers to establish bullish long positions in the next few months, however, it will accelerate the shift into backwardation.
Portfolio managers tend to invest in futures contracts near to maturity since they offer the greatest volatility and liquidity: position-building therefore tends to lift spot prices and increase the degree of backwardation.
If the hedge fund community becomes more convinced the economy and oil consumption growth will accelerate in 2020, position building will cause the backwardation to become even steeper.
The writer is a Reuters market analyst.