Look Past OPEC Freeze Hype to Really Understand Oil’s Advance

BofAML's Blanch: Oil Will Hit $55 by Year End
  • Fading contango is clearest sign of recovery: Credit Suisse
  • Market moving from massive surplus to balance: BofAML’s Blanch

For all the feverish speculation of OPEC action that’s roiling oil markets, the real reason for crude’s recent recovery probably lies elsewhere.

Oil futures have rallied more than 10 percent since the Organization of Petroleum Exporting Countries said it would hold informal talks in Algeria in late September, fueling expectations it could revive a pact on freezing production. Banks from Citigroup Inc. to Bank of America Merrill Lynch see a simpler explanation for the rebound: the global oil oversupply is finally dissipating.

A narrowing discount -- also known as contango -- on immediate supplies of Brent crude is the “clearest indicator” that the two-year glut is fading, Credit Suisse Group AG said. The spread between the first monthly Brent futures contract and the sixth has contracted more than 40 percent in the past month, data from the ICE Futures Europe exchange show.

“OPEC remains very dysfunctional,” Francisco Blanch, head of commodities research at Merrill Lynch in New York, said in a Bloomberg Television interview. “The reality of the matter is in the last six months we’ve moved from a massive surplus to a balanced market, and now we’re moving into deficit. The market is tightening -- you see it in Brent spreads.”

Coming just days after oil fell to a three-month low near $40 a barrel, OPEC’s Aug. 8 announcement that it would hold “informal talks” in Algiers fostered a rebound in prices, even though most analysts doubt the group will agree on any production limits. While markets have been fixated on OPEC speculation, robust demand is whittling away brimming oil inventories, according to Blanch.

OPEC is unlikely to agree on a freeze next month as the same political rivalry between Gulf members Saudi Arabia and Iran that thwarted a similar initiative in April remains an obstacle, analysts from Citigroup to Commerzbank AG say.

Signals from producers that the group may act are simply “jawboning” to push prices higher, Ed Morse, head of commodities research at Citigroup in New York, said in a Bloomberg Television interview.

“I suspect that there’s not going to be much happening” in Algiers, Morse said. More importantly, declines in the “huge oversupply” of crude and products mean “the market is really moving into balance.”

The front-month Brent contract on the ICE Futures Europe exchange was about $1.80 barrel cheaper than the sixth month, compared with a spread of $3.08 barrel on July 29.

It’s still hard to deny that OPEC’s verbal intervention has been effective, spurring a “sharp reversal” in sentiment, said Jeff Currie, head of commodities research at Goldman Sachs Group Inc. Hedge funds pulled bets on falling oil prices at the steepest rate on record in the week to Aug. 16, according to data for the U.S. benchmark, West Texas Intermediate, from the Commodity Futures Trading Commission.

There’s also no consensus among analysts that the market is on the mend. Demand for crude oil remains “anemic,” gasoline consumption is slowing around the world and disrupted supplies from troubled OPEC members Iraq and Libya may be poised to recover, Morgan Stanley says.

“Improved fundamentals are not a key reason for the recent price rebound,” said Adam Longson, commodity research analyst at Morgan Stanley in New York. “We see poor or deteriorating fundamentals in many areas. Supply has also returned and appears set to surprise to the upside.”

The strengthening of the market may be obscured as inventories in regions with the clearest data, such as the U.S., remain excessive, said Citigroup’s Morse. Yet in other places, such as in OPEC leader Saudi Arabia or even on tankers where crude is stored at sea, stockpiles are indeed “pulling down,” he said.

With crude production in the U.S. retreating amid reduced drilling, total oil inventories in industrialized nations will finally decline in both the third and fourth quarters, after accumulating for the past two years, said Jan Stuart, global energy economist at Credit Suisse Securities LLC.

“OPEC and talk and noise -- wake me up when the Saudis begin to talk for real,” Stuart said in a Bloomberg Television interview. “Markets rally, Brent structure strengthens -- maybe it’s that simple.”

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