One of the most interesting features of the recent developments in oil markets has been the sharp change in the shape of the Brent futures curve. This has been in backwardation (near term prices higher than future prices) since the start of last year but in the space of a couple of days last week flipped into contango. A backwardated curve is a disincentive to store oil and is typically indicative of physical tightness in the market. So, the change in the shape would be consistent with our thesis that supply has substantially exceeded demand this year leading to a rebuild in inventory. In our view, the abrupt change in the shape of the curve speaks to price capitulation in the market. That means the Brent price is likely to be even more vulnerable to further downside risk, while over-supply continues, we anticipate.
While the call on OPEC crude should increase in 2H12, at May production levels it is still likely exceed demand by 1mmb/d, we estimate. There still appears to be a widespread expectation that the imposition of new US sanctions and the Euro embargo will lead to a further substantial loss of perhaps 1mmb/d in Iranian supply to the market. We expect the net impact to be much smaller. That would leave the primary onus on Saudi Arabia to cut volume if it wants to defend USD 100/bbl Brent and we believe that it does, with action potentially brought forward should the price fall below the USD 90/bbl mark on a sustained basis.
ICE Commitments of Traders data for the week to 19 June confirms a continuing sell-off in speculative net long futures and options position which dropped 10,675 positions (-6.8%) WoW. Interestingly, net managed money longs, generally considered the most speculative component, were virtually flat WoW but the oil price has since suffered its worst weekly drop in four weeks.