Brent spreads have weakened sharply in recent days as traders become less convinced the oil market will rebalance early in the second quarter.
The calendar spread from May to June has eased from 6 cents contango per barrel on Feb. 21 to 30 cents contango on Feb. 27 (tmsnrt.rs/2lP8pbF).
Calendar spreads track the balance between crude supply, consumption and stockpiles, with contango indicating a market in balance or oversupply, while backwardation is associated with a fall in stocks.
Most traders and forecasters expect the oil market to shift from a supply surplus in 2014/15 to a deficit in 2017/18 with a corresponding shift from contango to backwardation.
But the timing and profile of the transition is subject to considerable uncertainty and has become one of the most popular plays for hedge funds and other traders.
Spreads for the first few months of 2017 rallied consistently and sharply since the middle of January before backing off in recent days.
The rally and subsequent reversal has been concentrated in the second quarter while spreads for the third and fourth quarter have been much more stable (tmsnrt.rs/2lP0w5W).
The rally and reversal were most pronounced in Brent though a similar pattern has been visible in spreads for WTI (tmsnrt.rs/2mzz22Q).
Hedge funds accumulated a large net long position in WTI spreads following the announcement of production cuts by OPEC and non-OPEC countries in November and December 2016.
But the net long position has fallen from a recent peak of 160 million barrels in mid-January to 127 million barrels on Feb. 21.
The net position declined by 18 million barrels in the most recent week alone and is back to levels last recorded in December (tmsnrt.rs/2m2bbe9).
Hedge funds and other traders bet the market would rebalance even faster than expected with a large draw down in stockpiles between April and June.
But in recent days that confidence has evaporated and the market is back to anticipating the draw down will start in earnest in the third quarter.
Crude traders moved too early and aggressively in pricing in a tighter market and a big draw down in stockpiles and now they have backed off, at least for the time being.
* “Oil volatility migrates from flat prices to spreads”, Reuters, Feb. 24
* “Brent market tightens sharply as traders eye stock draws, possible squeeze”, Reuters, Feb. 21
(John Kemp is a Reuters market analyst. The views expressed are his own.)
(Editing by David Evans)