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Column: OPEC's focus on stocks risks prices overshooting - Kemp

From Reuters - January 3, 2018

LONDON (Reuters) - The Organization of the Petroleum Exporting Countries (OPEC) is sticking doggedly to its plan to cut commercial oil inventories down to the five-year average to rebalance the oil market.

But in doing so, the organization risks tightening the market too much, sending prices sharply higher and encouraging a faster-than-expected acceleration in production from U.S. shale producers.

Saudi Arabias oil minister, who is the organizations de facto leader, has reiterated that stocks are still around 150 million barrels too high and it would be premature to discuss an exit strategy or change of course.

Almost the single metric we look at is global inventories and of course the most transparent and trustworthy is the OECD, he said in an interview before Christmas (Saudi energy minister Q&A with Reuters, Dec. 20).

OPEC, the International Energy Agency (IEA) and the U.S. Energy Information Administration (EIA) all have slightly different figures for OECD commercial crude and products stocks, but they show a similar trend.

OPEC estimates that total stocks were around 137 million barrels higher than the five-year average in October, down by around half since May (Monthly Oil Market Report, OPEC, December 2017).

IEA puts commercial stocks about 111 million barrels above the prior five-year average at the end of October (Oil Market Report, IEA, December 2017).

EIA data shows commercial stocks 167 million barrels above the five-year seasonal average at the end of October, down from a surplus of 380 million barrels in July 2016 (tmsnrt.rs/2CgLBYl).

While the specific numbers differ, mostly for definitional and methodological reasons, the data from each of the agencies shows the stock overhang compared with the five-year average has narrowed significantly.

Most of the remaining overhang is concentrated in crude oil rather than refined products such as gasoline and heating oil.

Product inventories are already tight in some cases, notably for middle distillates such as gasoil, diesel fuel and heating oil.

BRENT SPREADS

OPEC seems determined to drive total stocks down to the five-year average, or very close to it, before starting to increase its own output.

But that would almost certainly leave stockpiles uncomfortably low, send benchmark Brent prices well above $70 per barrel and push the market into a big backwardation.

Global oil consumption has increased by more 6 million barrels per day over the last five years, according to the EIA.

Other things equal, the oil industry will want to carry significantly higher stocks in 2018 than in 2013 to cover the increase in consumption.

Brent futures prices for the next six months are already trading in a backwardation of around $2 per barrel, which is consistent with a market that is already tight and undersupplied.

The six-month Brent calendar spread is trading around the 78th percentile of its historical range, up from the 22nd percentile at the same point last year.

The calendar spread is watched by many physical traders as the most reliable indicator of the balance between production, consumption and inventories.

Backwardation is normally associated with a market that is undersupplied and a low and declining level of inventories, while contango is normally associated with oversupply and high/rising stocks.

The Brent market has cycled regularly between backwardation and contango over the last 25 years as it moves between periods of under- and oversupply.

The sustained shift from contango in 2015/16 to backwardation in late 2017 and at the start of 2018 strongly suggests the market has switched from oversupply to undersupply.

Calendar spreads for all months in 2018 have tightened significantly over the last six months suggesting traders see the market moving towards a sustained period of undersupply.

SEASONAL VARIANCE

TIGHTEN TOO MUCH

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