Oil prices: From backwardation to contango, where do we go now
Contango shows that markets are concerned about oversupply as Iranian crude oil will not see sharp drop in near term
Spot Brent crude prices closed below $70 a barrel on Friday. For the last one week, Brent crude prices have moved into what the markets call contango, a phenomenon where the spot price is lower than that of a futures contract. The chart above has the details.
Contango indicates that the markets are concerned about oversupply at the moment. The recent fall in oil prices was triggered because the US granted waivers to eight countries to continue importing crude oil from Iran (including India and China, top buyers of Iranian crude oil) for 180 days. The markets are relieved that Iranian crude oil supply in the global markets will not drop sharply in the near term, even as the exact quantum is not clear.
In general, the risk-off sentiment in the markets (seen in October) and an environment where interest rates are rising have also cast its shadow on crude oil prices. Additionally, there have been concerns on the demand outlook.
Moving ahead, the million-dollar question is the direction that crude oil prices will take. According to Ashray Ohri of ICICI Bank Ltd, “While a further fall may be warranted based on US’s temporary exemption on Iran and demand concerns, we believe oil prices are more likely to move to the upside as Iran exports get depleted further.”
Having said that, is $80 a barrel on the horizon?
“We believe a Brent rebound above the $80 a barrel level is less likely based on the current fundamentals and more responsible statements made by the US administration,” wrote Ohri in a report on 6 November. “As such, we expect oil prices to trade around the $75 a barrel mark and average $77 a barrel in the fourth quarter of this year, before cooling further to average $75 a barrel in Q1 2019.”
Of course, much also depends on the stance that the Organization of the Petroleum Exporting Countries and its friends take on production cuts.
For now, lower crude oil prices are good news for us, as India imports a huge portion of its oil requirements. Lower prices benefit the country’s current account deficit and ease pressure on the rupee. For many corporates too, easing crude oil prices will bring some relief on the costs front.
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