Weakening Brent Spread and Lower BP Break-Even Price Suggest Downside Risk is Greater

So far it's been a dismal week for predictions about where the market is headed overall

Analysts who recently predicted that downside risks will increase given all the negative factors impacting oil, and despite Organization of the Petroleum Exporting Countries (OPEC) production cutbacks, were proven accurate as a report published Tuesday revealed that Brent spreads have weakened sharply.

Reuters notes that the calendar spread, which tracks the balance between crude supply, consumption, and stockpiles, has eased from 6 cents contango per barrel on February 21 to 30 cents contango on February 27, as traders become less convinced that the market will rebalance early in the second quarter as OPEC and many of its members insist.

Reuters goes on to observe that while most traders and analysts expect the market to shift from a supply surplus in 2014/15 to a deficit in 2017/18 with a corresponding shift from contango to backwardation, "the timing and profile of the transition is subject to considerable uncertainty and has become one of the most popular plays for hedge funds and other traders."

While hedge funds accumulated a large net long position in West Texas Intermediate spreads following OPEC's announcement of production cuts in November, the position has fallen from a recent peak of 160 million barrels in mid-January to 127 million barrels on February 21 - and in the most recent week alone, the new position declined by 18 million barrels back to the levels of December.

Reuters states, "Hedge funds and other traders bet the market would rebalance even faster than expected with a large draw down in stockpiles between April and June; but in recent days, that confidence has evaporated and the market is back to anticipating the draw down will start in earnest in the third quarter."

Meanwhile, another sign of a potentially greater downside risk came in the form of BP reassuring investors about its growth outlook and finances: Bob Dudley, chief executive officer of BP, said in a statement Tuesday that his company will need a crude price of about $40 per barrel in 2021 to cover spending and dividends, down from $60 this year.

The $60 prediction, made at the beginning of February, was based on the cost of buying oil and natural-gas fields in Egypt, Mauritania, and Senegal; Dudley predicts the break-even price will drop steadily from this year to $35-$40 four years from now.

So far it's been a dismal week for predictions about where the market is headed overall: on Monday, Stephen Brennock, analyst for PVM, stated, "With speculators increasing their bullish bets on U.S. crude to an all-time high, the risk of disappointment and subsequent downward spiral in prices has never been greater."