LONDON: A recovery in US crude exports and falling European refining margins have sent prices of North Sea barrels tumbling, which may encourage traders to keep oil in storage and could undermine OPEC's efforts to drain inventories.
The Organization of the Petroleum Exporting Countries, Russia and 10 other producers agreed to cut output by about 1.8 million barrels per day (bpd) since January to push prices up and draw oil out of storage to fill the gap.
In August, the ICE Brent futures market near-term prices exceeded longer-term ones, a condition known as backwardation that indicates tighter supply. Prices followed suit in the physical market, which uses Brent as a benchmark.
When Hurricane Harvey hit US Gulf Coast refineries in late August, Brent crude futures neared their highest in nearly two years close to $60 a barrel, while prices for key North Sea grades hit multi-month, or even multi-year highs.
As US refineries recover, near-term future prices have started to retreat again, while physical market prices, a relatively reliable indicator for futures market, have shown a more dramatic reversal.
The prompt dated Brent price, used by traders in the physical market, is now at a discount of about 3 cents to oil for delivery in three months' time. That is down from a premium 10 days ago of $1.40 a barrel, which was the largest since 2014.
The bigger the discount of prompt prices to future ones, the greater the incentive for owners of physical barrels of oil to store it for sale in the future when it will sell for more.
"The pressure that we've seen since end of last week in the North Sea market is a very bearish flag for Brent futures timespreads," Petromatrix strategist Olivier Jakob said.
Energy analysts Kpler estimate that, at the end of last week, the amount of oil kept on ships in the North Sea rose by nearly 3 million barrels to just over 5.4 million barrels in the space of a week, in line with Reuters calculations.
The premium of front-month Brent futures over the second-position contract is now at 21 cents a barrel, down from closer to 75 cents as the contract expired last week.
Demand for North Sea crude has risen by 5 percent year-on-year to around 1.74 million barrels per day in the first nine months of this year, according to Reuters trade flows data, which had helped tilt the forward market into backwardation.
"When we had the hurricane disruptions, that translated into strong margins and disruptions to US crude exports. So on that basis, it made sense to speculate on strength in the North Sea market. Since then, US refiners are coming back and US exports last week were at a record high on a weekly basis," Petromatrix's Jakob said.
Traders in the physical markets have flagged the steep drop in European refining margins, particularly for gasoline, which has started to feel the pinch from rising inventories, while prices for other products such as jet fuel have hit multi-month lows.
With more market participants offering North Sea barrels, the ICE Brent futures structure had "room to collapse", one said.
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