It is highly likely that the oil market may remain in a contango state in the long term. Analysts believe that it might be oil’s fate after supply and demand eventually balance. It will happen due to the massive amount of crude and products in storage, according to a May 29 Reuters report that cited investment banks and analysts.
By description, contango is the state experienced in the market where the prices of a commodity for delivery at later times are higher than the current prices. That is technically a market situation that indicates oversupply. In this case, the traders use the situation to store oil for delivery at a later date.
The opposite market situation is known as backwardation, and it usually happens at times of market deficit. In these times, the prices for the front-month contracts are notably higher than those that are further out in time. The supply and demand balance on the oil market may drop into deficit as early as this June; according to reports by some analysts like Goldman Sachs.
Increasing global oil demand and faster-than-expected production curtailments arising from outside the OPEC+ pact will expectedly push the oil market into deficit next month. But, there is a small space for an oil price rally in the near term since there is still a considerable oversupply of refined products and crude oil; as explained by Goldman Sachs in their middle of May note.
However, the contango on the oil market may persist beyond the current deficit since there is a large amount of oil on floating storage based on Citi’s data cited by Reuters:
“An inflection point is happening in physical fundamentals, although oil-on-water may cast a shadow on the recovery.”
The Super Contango
In the ‘peak lockdown’ period, when all of the major economies were under lockdown in late March and early April except China; the oil market experienced a significant contango. The glut grew rapidly and massively. Oil storage capacity shrunk extensively as the oil demand plunged to historic lows. Also, Saudi Arabia, OPEC’s leader and the world’s biggest exporter, wanted to dismantle the market with a supply surge.
But, the United States intervened, and a new deal was reached with Russia for record production cuts. Since the start of May, demand has restarted, and the road to recovery is gradual but continuous. There is supply coming off the market arising from the OPEC+ cuts and economics-driven curtailments happening in North America.
However, the massive amounts of oil in storage may keep the market in contango even though it might drop into a deficit. There is oil stored in floating ships for which the traders have chartered tankers for the next six months.
Analysts and commentators believe that as more economies continue to reopen, demand will rise again. In that context, the price of oil may briefly rise before the contango pulling it back to its current situation for the middle-term and maybe the long-term.
