May 14, 2020 / 4:53 PM / 10 days ago

UPDATE 1-Brent oil market structure, physical rally could draw oil from storage

(Adds latest product stock draws, IEA refining data)

By Alex Lawler and Julia Payne

LONDON, May 14 (Reuters) - The oil futures market is pricing in tighter supplies due to OPEC-led production cuts and recovering demand as lockdowns to contain the coronavirus outbreak are eased, suggesting a huge inventory buildup could slow and start to be drawn down.

Brent crude futures for July are trading at the smallest discount to the contract six months in the future since March LCOc1-LCOc7. A price structure where oil for immediate delivery is cheaper is called contango. A narrowing contango usually points to supplies becoming more constrained.

At the same time, the price of North Sea physical oil compared with dated Brent - the benchmark used to price most of the world’s cargoes - has recovered from historic discounts and is moving toward parity. IHBFO-DTD

The changes arise against the backdrop of supply cuts led by the OPEC+ group of oil producers and reductions by other producers, such as the United States. Government lockdowns to limit the spread of the coronavirus have also begun to be eased, pointing to a recovery in fuel use.

In a sign of rising fuel demand, stocks of all refined product held in independent storage in the Amsterdam-Rotterdam-Antwerp (ARA) oil hub fell 4% in the week to Thursday, data from Dutch consultancy Insights Global showed.

“The supply and demand balance is tightening,” said Olivier Jakob, analyst at Petromatrix. “The physical market is moving towards some rebalancing and away from the heavily over-supplied condition.”

The record contango that arose due to the collapse in demand caused by the lockdowns had encouraged a vast buildup of oil in storage that had strained available storage capacity and led to a record amount held in ships at sea.

Now the incentive to keep adding to storage has weakened. Crude traders said demand for oil for immediate delivery had increased, as supply cuts had surprised on the upside.

“There is an improvement. People are getting back to work,” a North Sea trade source said. “Hopefully we’ll see some crude that’s in storage being drawn on.”

Another trade source said the narrowing contango was creating a temptation to offload some stored crude, or at least to swap the oil being held in tanks for another grade if it was in higher demand.

Still, the physical rally could have run too fast. The International Energy Agency said it saw the refining slump extending into May with current throughput down over 14 million barrels-per-day versus last year.

Eugene Lindell, analyst at JBC Energy, said a drop in refinery profit margins could put a brake on the gains.

“The physical differentials are currently doing very well,” he said. The big fly in the ointment is that crude buying interest is ebbing given weak refinery margins on the back of elevated product stocks. Hence, we are cautious on the sustainability of this mini rally - at least in the short term.”

Additional reporting by Shadia Nasralla, Dmitry Zhdannikov and Olga Yagova. Editing by Mark Potter and Elaine Hardcastle

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