(John Kemp is a Reuters market analyst. The views expressed are
* Chart 1: tmsnrt.rs/2h6AZks
* Chart 2: tmsnrt.rs/2gnIVQ0
By John Kemp
LONDON, Dec 8 Crude traders expect the oil
market to begin tightening and gradually move into deficit, but
the shift is not forecast to occur much before the second half
The expected timetable for rebalancing is revealed by the
changing relationship between Brent futures prices for different
months in 2017 and 2018.
Holbrook Working of Standard University's Food Research
Institute explained the relationship between stocks and futures
prices over 80 years ago ("Price relations between July and
September wheat futures", 1933).
Traders' expectations about the balance between supply,
demand and stock levels are reflected in the shape of the
futures price curve.
If supply is expected to exceed demand, and stocks are high
and rising, futures prices will normally trade in a structure
called contango, with prices for nearby delivery dates below
those for later delivery months.
Discounts for nearby delivery months reflect the cost of
financing and storing excess stocks until they can be resold and
consumed at a later date.
But if demand is expected to exceed supply, and stocks are
low and falling, futures prices will normally trade in the
opposite structure, known as backwardation, with nearby prices
above those for later delivery.
The premium for nearby delivery months helps make more
supplies available immediately and discourages short-term
consumption to conserve stocks for future use.
In the oil market, changes in the balance between supply and
demand have usually been closely associated with changes in the
structure of Brent futures prices over the last two decades (tmsnrt.rs/2h6AZks).
Periods of oversupply, such as 1997/98, 2008/09 and now
2014/16, have been associated with a progressive shift into
Periods of rebalancing and stock draws, such as 1999/2000
and 2010/11, have been associated with a progressive shift
Futures prices are driven by expectations about future
supply and demand, so they are a best guess, not an infallible
Traders can sometimes be wrong: the contango in Brent
narrowed significantly in the first half of 2016 as traders
anticipated an early rebalancing of the oil market that failed
The shape of the curve can also be temporarily distorted by
a lack of liquidity further along it, and large-scale hedging.
Nonetheless, the structure of futures prices can provide
useful clues about how traders in aggregate expect the balance
between supply and demand to shift.
WATCH THE SPREADS
The difference between futures prices for different delivery
months is commonly called the "time spread" or "calendar
spread", which is simply a way of measuring the degree of
contango or backwardation between two dates.
OPEC's agreement to cut 1.2 million barrels per day from its
members' production starting in January 2017 triggered a sharp
rally last week in Brent time spreads for all periods in 2017
and 2018 (tmsnrt.rs/2gnIVQ0).
Traders anticipated the planned cuts by the Organization of
the Petroleum Exporting Countries would reduce global oil
supplies and lead to a drawdown in stockpiles in 2017.
But in the last few days, time spreads for the first half of
2017 have given up much of their earlier gain, while those for
the second half of 2017 and throughout 2018 remained firm.
OPEC and Russia have been increasing output even as they
discussed future cuts, ensuring the market remains oversupplied
and will enter 2017 with high inventories.
By raising output so much ahead of a production-cutting
deal, OPEC members have made their task harder and pushed back
rebalancing well into next year.
Crude stocks are expected to remain very high throughout the
first half of the year, with the contango, currently around
$2.20 per barrel between February and June 2017, still much
wider than earlier this year.
But stocks are expected to start drawing down in the second
half of 2017 and through 2018, with the contango in those
periods now much narrower than at any point this year.
The contango for the second half of 2017 has shrunk to less
than 80 cents per barrel, while the contango for the first half
of 2018 is down to 25 cents and the second half to just 1 cent.
Traders are signalling they expect oil demand to exceed
supply in the second half of 2017 and throughout 2018, leading
to a big fall in stocks.
(Editing by Dale Hudson)