Oil Prices – Is Further Upside Possible?

The (virtual) OPEC+ meeting took place over the weekend, with some interesting decisions for the oil’ supply and demand chain. Now that the oil prices have recovered after the dramatic declines in April, (e.g. the price of the WTI crude oil futures contract slipped below 0), OPEC and its allies are ready to adjust the output in response to the expected increase in demand. 

The Process Towards Backwardation

What is interesting at this week’s OPEC+ decision is the way the cartel looked at the market – much like central banks trying to influence both the long and short end of the yield curve. Saudi Arabia, in particular, is trying to change the shape of the oil price curve -from contango to backwardation.

When the forward price of a futures contract is higher than the spot price, it is said that the market is in contango. Conversely, when it is lower, the market is said to be in backwardation.

It may not look like something important, but for OPEC+, it is a way to “disarm” the shale-oil industry in the United States. If we look back to the start of the coronavirus crisis, less than a month before the European countries entered lockdown, Russia and Saudi Arabia didn’t agree to a cut in production levels and created a huge gap lower on the price of oil when the markets opened on Monday.

The idea was that lower prices affect the shale-oil industry and drive many US businesses out of the market. To some extent, it worked, as the number of rigs in the United States declined ever since.

The current intention to move towards backwardation is aimed, yet again, to the shale oil industry. For shale oil producers, they have a benefit in higher longer-dated prices – they use them to hedge the current lower prices. A change will dramatically affect the current business model.

Will OPEC+ succeed?

This depends on how quickly they can adjust to supply and demand changes. Judging by the ambition of the plan and the complexity of controlling the crude oil prices curve, OPEC+ is more than determined to succeed. Achieving backwardation gives OPEC+ not only higher revenues, but also a higher market share, as it drives competitors out of the market.

The next OPEC+ meeting will take place towards the end of the year-end. However, until then, a small group of members (Saudi Arabia and Russia included) will constantly meet to make sure the plan is implemented and done so correctly.

The war on prices and market share is far from over. For sure, financial markets will closely watch the oil prices in light of OPEC+ efforts to reach backwardation.

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