(John Kemp is a Reuters market analyst. The views expressed are
* Chart 1: tmsnrt.rs/2mhTrZd
* Chart 2: tmsnrt.rs/2mhEB4W
* Chart 3: tmsnrt.rs/2lirXoA
* Chart 4: tmsnrt.rs/2mhKFKP
By John Kemp
LONDON, Feb 21 Brent futures prices for the
second quarter have risen strongly in recent days suggesting
traders expect the oil market to move into deficit earlier or
that a squeeze is underway.
Calendar spreads for nearby months have tightened sharply
since the middle of February to a level that will make storing
oil outside the United States unprofitable from the start of the
second quarter onwards.
The calendar spread from April to May has tightened from a
contango of 35 cents per barrel on Feb. 15 to just 17 cents on
Feb. 20 and is now trading around 12 cents (tmsnrt.rs/2mhTrZd).
The spread is now too narrow to cover the cost of financing
and storing barrels under any set of realistic assumptions about
the cost of borrowing money and leasing tank space.
Spreads are even narrower for later months, with a contango
of just 10 cents for May-June and 7 cents for June-July.
The spread tightening has been concentrated in the second
quarter which implies traders now expect a supply deficit to
occur from April rather than June (tmsnrt.rs/2mhEB4W).
Calendar spreads have tightened much more in Brent than in
WTI - where the spreads remain wide enough to finance crude
stockpiles in the United States through until about June (tmsnrt.rs/2lirXoA).
If the tightness in Brent persists, physical traders will
have an incentive to unwind cash-and-carry storage trades where
they hold a long position in physical oil and a short position
Physical barrels will be sold from stockpiles to refiners
and reported inventories should start to decline rapidly.
Senior OPEC officials have repeatedly cited a shift in oil
market structure from contango to backwardation as one of their
intermediate objectives for oil market rebalancing.
Hedge funds have accumulated a record bullish position in
crude futures and options in the expectation that OPEC will
Fund managers have also amassed a large bullish position in
options on the calendar spreads in a direct bet the market will
move from contango towards backwardation (tmsnrt.rs/2mhKFKP).
Hedge funds and other money managers have a net long
position in WTI calendar spread options (physical and financial)
equivalent to 144 million barrels that will make money if the
spreads continue to narrow.
The tightening spreads imply that traders see a higher
probability the market will move into deficit from the start of
the second quarter rather than the start of the third.
They could also indicate a lack of traders willing to take a
short position in the spreads given the likely market
But they would also be consistent with a squeeze, with one
or more traders accumulating a large long position in nearby
futures and threatening to take them to expiry.
The first rule for executing a successful squeeze is to
squeeze with the underlying fundamentals of the market rather
than against them.
The regular tightness of the Brent market in the second and
third quarters makes it vulnerable to squeezes at this time of
year if traders accumulate long futures positions (outright or
in the spreads) and then buy physical cargoes.
The Brent market is very small with only 40 to 50 cargoes
loaded each month, which means the purchase of even a small
number can tighten the market considerably.
Brent availability is often restricted during the summer
when field operators take advantage of better weather to
undertake routine maintenance.
And Brent maintenance corresponds with the annual peak in
oil demand during the U.S. summer driving season and the summer
airconditioning season in Saudi Arabia and Iraq.
If OPEC is successful in creating a supply deficit and
drawing down oil stocks, Brent could become very tight this
summer. A successful squeeze, or even just the possibility of
one, would make that tightness even worse.
Fundamental tightness and the possibility of a squeeze are
complementary rather than exclusive explanations for the
tightness of the Brent spreads.
OPEC’s expected success in draining inventories, hedge fund
bullishness about the shift from contango, and the possibility
of a squeeze are combining to push the Brent market towards a
* Hedge funds bet big on oil as OPEC gives them a free put
option, Reuters, Feb. 20
* Brent spreads imply big draw down in crude stocks after
June, Reuters, Feb. 13
* Hedge funds load up on calendar oil options to bet on
rebalancing, Reuters, Jan. 27
* Brent curve signals oil tanks will start emptying in
second half of 2017, Reuters, Dec. 21
(Editing by Susan Thomas)