Russia’s massive attack on Ukraine has pushed oil prices to $100 a barrel, a level that a few months ago seemed unreasonable and unattainable. However, the worst could still be to come if you look at the futures curve that shapes the oil market. The market is in a structure known as super-backwardation that usually anticipates sharp increases in the price of crude oil (this Tuesday it rebounds more than 6% and exceeds 104 dollars per barrel). This clear structure had not been seen since the Iraqi invasion of Kuwait in 1990.
futures markets They are used by economic agents to hedge their operations with relative certainty, since they can ensure the future price of certain raw materials and products (an airline can buy kerosene futures, ensuring a price within a year, for example). But this market is also useful for anticipating what may happen to the price of the goods or assets that are traded on it.
From the financial firm UBS they explain in a note that “if the futures curve has a negative slope (backwardation), as is currently the case for crude oil, investors can buy the futures at a discount and generate a positive return (wait for the future to expire and sell the more expensive crude).” Right now, the oil market is so tight and the risk premium is so high that spot oil (physical crude for immediate delivery) is much more expensive than futures (there is fear and scarcity), so holding crude to sell later can be profitable at while exacerbating the global oil shortage.
As futures get closer to their expiration and delivery date, the price rises strongly, which suggests that the market is eager to buy oil in the face of what may happen. In March and April 2020, the market structure was the opposite (contango). Oil was not being sold and its spot price was much lower than futures. This structure hinted that crude could continue to suffer falls, a hypothesis that was confirmed when West Texas fell even at negative prices. Now the market structure is antagonistic compared to March 2020.
Potential sanctions on Russian oil and very strong demand for crude are sinking inventories and creating some tension in the crude market. The price of a barrel could continue to climb and reach levels much higher than the current ones. Some analysts are beginning to anticipate that oil could hit $150 a barrela possibility that some investors already anticipate as can be seen in the options market, where more and more investors buy call options that bet on a barrel of crude oil at 150 dollars.
Backwardation vs contango
“The backwardation (opposite of contango) structure tends to occur when commodity markets are undersupplied. In all the recent life of Brent futures contracts, there has never been such an extreme premium between the shortest ( April) and the rest of longer-term contracts”. Currently, the first contract is trading about ten dollars above the sixth contract (which belongs to the month of October).
John Kemp, a commodity analyst at Reuters, assures that this structure in the oil market has not been seen since 1990, when Saddam Hussein’s Iraq invaded Kuwait unleashing a conflict in the oil heart of the world. Now the situation has some similarities, since Russia produces considerably more oil (about 10.4 million barrels per day) than Iraq and Kuwait combined (about 8 million barrels per day). The war between Russia and Ukraine is increasing the risk premium for oil even though there has not yet been a de facto disruption of Russian crude flows. To the above we must add the state in which this market was already found.
“The fall in oil inventories and the decrease in idle production capacity caused by the strong demand for crude are endorsing this figure of super-backwardation. Another likely factor supporting the structure of backwardation it is the refiners looking for alternatives to Russian crude for fear of sanctions, as seen in the steep discount offered by Ural oil to Brent. We maintain our positive outlook on crude oil and continue to advise investors to take risks and to get more exposure to longer-dated Brent oil contracts.”
From Bank of America Merrill Lynch they point out in a note that “the structure of backwardation should remain the dominant structure of the Brent crude oil market. This view is mainly supported by OPEC+’s mild intervention, declining slack and low inventories.” These experts forecast that Brent touches 120 dollars in the coming months, which will continue to add pressure on the wave of global inflation that is hitting almost all economies.
The future of oil
Warren Patterson, a commodity analyst at ING, agrees, adding that energy markets remain very well supported by uncertainty over Russian supply. In addition, this expert sees serious risks from an even more complex scenario: “We believe that the market has priced in some limited supply interruptions, but a scenario of sanctions on energy exports is not discounted. As a result, this leaves an upside risk if the situation deteriorates further.”
This environment of rising prices is increasing the probability of a coordinated release of oil reserves. Reports suggest the US and other countries are considering a possible stock release of 60 million barrels. The International Energy Agency will hold an emergency meeting on Tuesday, where a possible urgent release will be discussed.
These measures can provide temporary relief, but in no case permanent. The only options to unclog the situation go through a easing of tensions with Russia and the return of Iran to the oil market.
The economic consequences of the conflict between Russia and Ukraine will come in three different phases
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