By Devika Krishna Kumar
May 17 (Reuters) - A rally in U.S. crude oil prices recently
has put the market on its firmest footing since the rout started
in 2014, with the spread between prices for near-term delivery
and future delivery narrowing, suggesting the worst of the
supply glut may be over.
Oil prices in global markets have been lifted in the past
week by news of falling U.S. production and output disruptions
in Canada and Nigeria.
The production cuts are seen helping to rebalance a market
awash with excess crude oil, pushing up prices for NYMEX June
futures delivery CLc1 up as much as 11 percent in the last
four days. It settled on Monday at $47.72 a barrel.
Traders are watching the relationship between futures
contracts expiring later this year and similar contracts
expiring in late 2018. The spread, or contango, has narrowed to
its smallest margin since November 2014.
The narrowing contango suggests excess supply is finally
being reduced after years of overproduction, but if U.S. shale
producers ramp up drilling again the market may yet fall back.
With several U.S. shale producers saying they would turn the
spigots back on if prices recovered to about $45 a barrel, the
market has been bracing itself for renewed supply as prices
recovered from 12-year lows, but that may not happen quickly.
"We're not seeing any signs that the U.S. energy industry is
in a hurry to respond to a jump in demand because they're still
cutting back on projects," said Phil Flynn, senior energy
analyst at Price Futures Group.
As prices inched close to $50 a barrel CLc1 LCOc1 last
week, the oil rig count fell further to October 2009 lows,
suggesting U.S. shale producers may yet need even higher prices
to restart production.
The rebound in near-term prices has also driven hedging
activity that has suppressed the prices of later-dated
contracts. The discount for crude for delivery in December 2016
versus delivery in December 2018 CLZ6-Z8 narrowed to $1.21,
after a spread as steep as $8 in December 2015.
The December 2016 discount to December 2017 contract
CLZ6-Z7 , one of the most actively traded spreads, also
narrowed by the most since November 2014 to as low as 60 cents.
"To me, it suggests that the market balances are tighter
than what people have believed or generally the consensus has
been in recent months," said John Saucer, vice president of
research and analysis at Mobius Risk Group in Houston.
Hedging amongst producers has been active, with oil
companies taking their biggest short position in U.S. crude
futures since the summer of 2007, according to CFTC data, in
order to protect themselves against price falls.
Producer hedging has pressured longer-dated contracts,
contributing to the narrower spread. In a Sunday note, Goldman
Sachs said the hedging activity could cause the rally in those
contracts to stall.
There is even a possibility of backwardation in the short
term, where later-dated contracts are cheaper than near-term
contracts, as the market moves into peak refining season,
according to Barclays (LON:BARC) analyst Michael Cohen.
"We're of the view that the macro and oil specific factors
will align to get us into a situation where prices go down at
the end of summer. And then, come back up in line with seasonal
trends," he said.
Goldman added that the fall in supply happened more quickly
than expected, though they expect supply to rebound in 2017.
Hedge funds may play a role in the sustainability of the
rally in crude if their appetite for commodities ebbs, taking
with it the flow of cash.
Data from the CFTC shows hedge funds reduced bullish U.S.
crude oil bets for a second straight week last week, driven by a
one-third increase in short selling. Those funds still carry a
notable long position in the market, however. CFTC/
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