Attractive backwardation in oil markets for consumers

Last week, when Brent traded at USD 82.2/bbl we argued in Energy Market Drivers that price risks were neutral. At the time of writing, Brent trades marginally lower at 82.14.

This time, we take a more positive approach to the oil price outlook in the short term (the coming week) as the market increasingly will focus on OPEC+ and a possible extension of voluntary production cuts into Q2. We expect an announcement on Friday or in the week after. 

We stick to our view from last week that oil prices will continue to rise in the medium term and see prices in the mid-80ties later the spring and summer months. 

The market will keep a close eye on any news from OPEC+. The question is whether the cartel will extend the voluntary Q1 production cuts into the 2nd quarter. We would expect an announcement in early March in line with the announcements from Saudi Arabia last year on the Saudi voluntary cuts that were announced on a monthly basis. Hence, an announcement is likely on Friday or the week after.

We have long held the view that OPEC+ has no option but to extend the voluntary production cuts if they want to keep oil prices at the current level or slightly higher. If the cuts are not extended, the market will conclude that OPEC+ and not least, Saudi Arabia are no longer ready to lose market share to defend the oil price. If that is the case, we expect a drop towards the low 70ties or lower.

If we see an extension into Q2, we expect it to add more support to oil, and a more sustainable move to the mid-80s is likely. However, this is probably the consensus scenario today.

The chart below to the left shows the IEA’s global demand and supply forecasts based on their nonOPEC supply forecast. We have assumed that the OPEC production level is kept at the January level throughout 2024. It secures a small drop in global inventories in all four quarters (green bars). If OPEC+ does not fully or only partly extend the 2.2 mb/d voluntary cuts, we could see a relatively large build in global crude oil inventories. The purple bars illustrate a situation where OPEC+ production rises 2.2 mb/d from April to December 2024.

Over the last few weeks, we have seen more backwardation in the Brent and ICE Gas oil curves. More backwardation is generally seen as an indicator of tightness in the spot market, as consumers have to pay a higher price today than in the future to get hold of commodities. Hence, the market tells us we have an increasingly tight spot market.

The chart below shows the prompt spread (1. position vs 2. position.) in the Brent and the ICE Gas oil curve. In ICE Gasoil, we often see backwardation “spikes” ahead of contract-roll.

Notably, the backwardation has extended further on the Brent and ICE Gas oil curves. The difference between the 1 st and 12th positions is USD 6.1/bbl on the Brent curve. The last time we traded with this amount of 1-year backwardation, the front-month Brent was at USD 87.4 (late October 2023), and the time before, it was USD 90.4 (September 2023). Hence, we have more backwardation today despite the front-month is trading at a lower level. From a consumer hedging perspective, that is an appealing curve feature.

The picture resembles the ICE Gasoil curve and many other oil product curves.

TTF natural gas continued to drop last week, and the front-month contract is now at EUR 22.8 Mwh. The TTF spot price is thus basically at the the average for 2012-2021, which was approximately EUR 22 Kwh. If we consider inflation, gas prices are back below pre-war average price levels. We argue that the price outlook is now starting to look more balanced. Among other things, we see a high probability that Russian gas imports, which still cover 15% of EU imports, will drop in 2024. We have also started to see nascent signs of an industrial demand recovery. For more, see this research piece on gas prices we published last week.

Importantly, we now argue that consumers should cautiously start to scale into gas hedges that cover winter 24/25 or calendar-25 exposure.

In the short term, there might be more downside to gas prices. Primarily, we note that the weather forecast for Northern Europe points to another two weeks with temperatures well above normal. Hence, the last official winter week will also be characterised by little demand for gas in heating.

EUA prices have also continued to drop, though we are seeing some indications that prices might be bottoming out. We have seen more stable demand (cover ratio) at the EEX EUA auctions. We have also noticed that speculative accounts have stopped adding to short positions.

Short-term EUA prices could edge lower if gas prices see continued downward pressure. From a technical point of view, the EUR 50/MT for the benchmark DEC-24 EUA contract remain in focus. If this level is broken, more downside could be in store.

We hold the same view on EUA prices as gas prices regarding consumer hedging. We argue that consumers should cautiously start to scale into EUA hedges that cover calendar 24 and 25 exposure.

OPEC/OPEC+ will be in focus next week as the market awaits the expected announcement regarding a possible extension of the 2.2 mb/d voluntary production cuts. As discussed in this note, we expect an extension of the cuts that could push Brent towards the mid-80s. Inventory data remain in fashion, and Wednesday’s usual DOE data can potentially move oil markets. This week, we saw another rise in US crude oil inventories of 3.5 million barrels.

Regarding critical economic data, the calendar in the US is packed with data. We would focus on the ISM, the PCE core deflator and GDP data. In the Eurozone, we will see the release of the first CPI data for February. They can be decisive for when the ECB can start cutting rates. We also begin to see some data indicating that the Chinese economy might be slowly improving. Chinese stocks have also moved higher in the last couple of weeks.

Notably, for the EUA market, the focus remains on the EEX auctions and the so-called cover ratio that we see as an indicator for underlining EUA demand. Last week, the speculative position data (published every Wednesday) showed that speculative accounts bought small amounts of EUAs. It might indicate that the drop in EUA prices seen recently is not driven by speculators but by weak end-user demand. However, it could also suggest that speculators are starting to take profit on short positions, as they see limited downside from the current EUA price level.

Table 1 on the next page summarises our market views and hedging recommendations in the different markets we cover.

We maintain our long-held view that Brent prices below USD 80/bbl offer an attractive entry level for new consumer hedges for 2024, notably as the global growth outlook has improved. Hence, add to the hedge ratio if we see a setback in Brent below USD 80/bbl. The risk is growing that Brent has already moved to a higher trading range. 

Hence, even after the recent move higher in various oil products, we still recommend that consumers have a hedging ratio above their individual company benchmark. The backwardation in the oil product curves is a positive feature from a consumer hedging perspective.

Power, gas, and EUA prices might fall further in the spring, creating more attractive entry levels for new consumer hedges. However, prices have come off quite a bit, and much positive news is now priced in. It is time cautiously to scale into consumer hedges.

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