(John Kemp is a Reuters market analyst. The views expressed are
* Chart: tmsnrt.rs/2lLqoNg
By John Kemp
LONDON, Feb 14 Crude oil stockpiles are expected
to empty significantly during the third quarter as continued
production restraint from OPEC interacts with the seasonal
increase in consumption.
OPEC and non-OPEC countries are committed to reducing
production by an average of nearly 1.8 million barrels per day
in the first six months of 2017, with an option to extend cuts
for a further six months.
Production assessments by independent agencies suggest
compliance with the agreement has so far been high from OPEC
especially from Saudi Arabia and its allies.
Further reductions from non-OPEC could be phased in over the
next few months, with Russia in particular committed to increase
its production cuts progressively during the compliance period.
Set against this is the risk of "compliance fatigue" if OPEC
and non-OPEC countries become complacent and allow production to
rise towards the end of the period.
Past experience suggests compliance tends to weaken over
time as prices rise and the panic which made an agreement
possible in the first place fades.
To preserve their flexibility, OPEC and non-OPEC countries
have declined to commit themselves on whether the agreements
will be extended.
But the consensus within the crude market seems to be that
the cuts will be continued for a further six months, at least in
The alternative would be to flood the market with more 1
million barrels of extra crude from the start of July which
would likely increase stockpiles again.
Assuming production cuts are extended in some form, the
biggest impact is likely to come during the three months from
July to September.
U.S. refineries normally increase their crude consumption
sharply during the third quarter to meet strong demand from
motorists during the summer driving season.
Over the last decade, net crude inputs into U.S. refineries
have risen by an average of 840,000 barrels per day in the third
quarter compared with the first.
The third quarter is also when Saudi Arabia and Iraq
increase their own internal consumption of crude to meet
Direct crude combustion in power plants will cut the amount
of crude available for export by several hundred thousand
barrels per day from both countries.
Finally, the third quarter is when most North Sea producers
undertake maintenance, which cuts output of Brent and other
grades during the summer.
In sum, the seasonal increase in consumption and reduction
in output could combine to produce a particularly sharp draw
down in crude stocks over the three months from July to
Traders are currently betting storage tanks will empty
significantly during the third quarter based on the structure of
Brent calendar spreads (tmsnrt.rs/2lLqoNg).
The Brent spread for April-May is currently trading around
35 cents per barrel contango, which makes storage on land
profitable under most assumptions.
But the spread for June-July is only 19 cents per barrel
contango, which makes storage only marginally profitable,
depending on assumptions about the cost of financing and leasing
And the contango for September-October is currently just 2
cents per barrel which would make storage unprofitable under all
While the June-July spread has not changed much for the last
12 months the spread for September-October has tightened
The scenario encapsulated in futures prices is that the
market will move into a significant supply deficit over the
Physical traders will gradually lift their inventory hedges
and sell stocks to refiners to help meet the shortfall in
supplies from producing nations.
This scenario is only one possible outcome and there are a
number of risks to the expected rate of market rebalancing.
Stocks could draw down faster than currently expected, in
which case the supply-demand situation would become very tight
in the third quarter. OPEC might respond by allowing production
On the other hand, growing U.S. shale output, weakening
compliance from OPEC and non-OPEC, and any slowdown in
consumption growth could all push back the draw down in stocks
and cause spreads to weaken.
The movement of the Brent spreads for June-July,
September-October and December-January should therefore provide
a real-time indicator of whether traders think rebalancing is
still on track or slipping.
(Editing by David Evans)