Demand Recovery Reaches Maximum Velocity
Crude oil approached multi-year highs last week as the velocity of the demand recovery narrative nullified negative short-term data points. Last week, the U.S Energy Information Administration (EIA), the International Energy Agency (IEA) and the Organization of the Oil Exporting Countries (OPEC) released their monthly oil market reports. On Tuesday, the EIA forecast fuel consumption growth this year in the United States, the world’s biggest oil user, would be 1.49 million barrels per day (bpd), up from a previous forecast of 1.39 million bpd. The IEA monthly report (released on 6/10) maintained it’s forecast that oil demand will surpass pre-Covid levels by the end of 2022. However, some expect the pace of the demand increases to moderate after July, expecting 2/3 of the increase in oil demand from May 2021 to July 2022 to occur in this month and next month alone.
There is nothing more that oil markets love than a bullish forecast in end-user demand. The monthly oil reports that were released last week did nothing to dampen demand growth forecasts. Yet, market participants grapple with comparisons of ‘outright’ price level appreciation from last year’s lows. Last year is NOT the baseline, it’s an anomaly. In fact, it’s almost comical how one can simply erase last year’s price action and replace it as if nothing happened (blue box below, shifted back in time, pre-pandemic). It’s as if we have hit the reset button and the price action of 2020 is nothing more than an anomaly and we are simply going to pick up where we left off before the pandemic ever happened.
Yet, historically, we are approaching price levels that are dicey. This is visible not only in outright price charts but also in the all-important calendar spread market. When market action is bullish, it’s reasonable to expect that it’s front-led. The spot market supports the price action. This has not been the case until recently as front-month futures have been relatively weak into expiration. Until recently, that is (monthly calendar spread expiration below).
As of last Friday’s close, the market has decided that the peak in the supply vs demand narrative will reach it’s peak September (Sep/Oct calendar spread, gold line above). The mere fact that the peak in one-month calendar spreads continues to be deferred to the future suggests that the upside move may not yet be finished. Future expectations of the pain point between supply and demand continues to be ‘kicked on down the road”. As long as this is the case, the market can continue to rally. At some point, however, this narrative will need to be realized. For now, the market isn’t too concerned with relative weakness in front-month spread expirations. The mere fact that the June/July spread was able to endure the monthly fund roll and hold on to backwardation was viewed as quite a bullish signal in the market (green line above). We believe it’s incumbent on the future realization of front month calendar spreads to support further upside momentum in outright oil prices, as it took a positive expiration of the front month spread to catapult outright prices to new highs.
One month spreads are very granular and may not provide enough context to the sustainability of this rally. There have been many times over history where a short-term event has pushed front month prices higher/lower without a follow-on response in the rest of the curve. This usually means that the conditions that exist today are expected to be resolved in the future. For context on this, we compare 6-month calendar spread futures across time in WTI.
What’s most notable about the chart above is that the deferred 6-month spread (red line above) has been the leader overall as the ‘swing vote’. It is the harbinger of future sentiment. In 2021, the deferred 6-month spread has been the leader showing much more strength than the front 6-month spread, crossing the zero-line into backwardation first (red line vs purple line below).
That brings us to outright calendar strip prices. As of last Friday’s close, the calendar 2022 strip was well above $60 while calendar 2023 staged it’s first settlement above $60 (settling at $60.08). Will this be a trigger for producer hedging? If so, this could provide the catalyst for the next move higher in spreads: producers using front month strength to sell the back of the curve. To date, we have not seen hedging activity materially impact longer-dated futures.