The legacy crude production impact from the Texas blackout, the unilateral Saudi cuts in February/March, and the loosening of COVID restrictions as vaccines are distributed will accelerate already brisk global destocking. It is likely that global oil stocks will be back below the five-year average much earlier than previously forecast, and as early as this quarter.
The US was already destocking at a brisk rate in the final quarter of 2020. Weekly EIA data for total US crude and products stocks fell 83 million barrels during the final quarter of 2020, or ratably at 900,000 bpd. During the first seven weeks of 2021 (through week ending Feb 19th) total US crude and product stocks dropped another 81 million barrels or 1.65 million bpd, almost double the rate of 4Q20.
These rapid shifts in inventory cover that have driven deep backwardation and the rally on WTI’s Dec (2021) vs Red Dec (2022) spread to all-time contract highs. The Dec vs Red Dec spread, both in WTI and Brent, is an excellent barometer for curve strength and term structure. These spreads are highly liquid with a large component of managed money/speculative participation in the open interest.Likewise, it is the Dec vs Red Dec and the Red Dec (2022) vs Blue Dec (2023) crude spreads that are widely used by banks and merchant to warehouse the risk they assume when crude strips are purchased from producer hedgers. We would argue these key curve spreads are usually a better indicator of market balance, and fundamental “health”, than flat price trading levels.
The Dec vs red Dec WTI spread made a new contract high this week at +$4.17/barrel backwardation. During the spring of last year this spread traded as low as -$3.39 contango. We would note that the previous contract high was in Oct 2018 at +$3.14, a day when prompt WTI futures settled at $72.98. After bottoming at -$3.94 last spring the Brent Dec/Red Dec spread is now trading +$3.50.
Note that the destocking discussed above occurred prior to any supply impact from the Texas freeze. Likewise, Saudi production cuts this month and next, because of their long-haul nature (4–6-week tanker route), will not be felt in refining centers until March and April. As such, the market is set up for a further acceleration of destocking into the spring. Stipulating Trafigura’s reported estimate of a 40 million barrels loss in US crude supply as a result of the Texas blackouts, the US market is already another 400,000 bpd tighter over the next 100 days from freeze impact alone.
Given the additional prompt supply losses, there is a strong likelihood crude backwardation will become more pronounced even prior to the expected seasonal recovery in US refinery runs from April. However, curve shape can be a mixed blessing. Steep backwardation rewards producers with high prompt realized prices for their physical barrels. The flipside is that the same backwardation also makes long dated producer hedging more challenging in an environment where Cal 2025 is trading almost $10.00 under Cal 2021, and where capital partners, both debt and equity, often require swap heavy, high hedge ratio, PDP hedges three-five years forward.