OPEC to push Brent forward curve into backwardation: BofA

OPEC is expected to push the Brent crude oil forward curve into backwardation, resulting in lower refining margins, lower prices for shale producers, and reduced downside oil price risks, Bank of America Merill Lynch said in a new report.

Pursuing oil backwardation will likely reduce refining margins as the cartel looks to “recapture dollars away from refiners,” analysts at BofA pointed out. OPEC produces about 33.5 million barrels per day (mbd) of crude but only refines 9.2 mbd.

Moreover, backwardation could squeeze forward oil sellers like shale oil producers or even non-OPEC governments like Mexico.

“With crude timespreads remaining in contango for two years now, spot sellers in the cartel have suffered the downturn more so than forward sellers,” the report said, noting that forward sellers in fact have benefitted in relative terms, as 12 and 24-month forward prices have averaged $5.6/bbl and $8.9/bbl above spot during the past two years, respectively.

Additionally, downside risks are easier to manage in backwardation – a crucial factor for producers like Saudi Arabia, which has burnt through $180 billion in foreign exchange reserves since oil prices began to tumble.

OPEC, therefore, has historically favored backwardation as it makes crude markets easier to price-manage, allowing producers to capture revenues from refiners, and enabling spot sellers to capture revenues from forward sellers.

“It should thus come as no surprise that Brent has spent 54 percent of the time in backwardation during the past three decades. Meanwhile, WTI, a landlocked regional market where OPEC's influence is much less visible, has spent only about 45 percent of the time in backwardation,” the report said.

But while Saudi Arabia and other OPEC members would be better off if the market moved into backwardation, challenges remain, like high product inventories across the OECD.

“Backwardation will most likely not occur unless total OECD oil stocks draw by at least 150 to 200 million barrels,” BofA said, noting however, that the "clean up" process has already begun, and OECD crude stocks have been on the decline for a few months.

Still, Saudi Arabia will likely have to “maintain some degree of production discipline” within the cartel to reduce global stocks, the report said.

“Since production discipline starts at home, Saudi stocks will remain a key variable to watch as the market rebalances.”