Correlations between spot and deferred oil prices are at the lowest for more than four years
Forget spot prices. The truly remarkable story in the oil market is what is (not) happening at the back end of the futures curve.
Front-month Brent futures prices have climbed almost US$17 per barrel (15.6 percent) since the start of the year. And prices for oil delivered in December 2015? Well they have risen a whole US$3.35 (3.6 percent).
Correlations between spot and deferred oil prices are at the lowest for more than four years as the back end of the curve fails to rally in line with nearby futures prices (Chart 2).
While spot Brent prices are back to the levels recorded in the first half of 2011, prices for deferred contracts are significantly lower than at the corresponding point last year. December 2015 futures are trading around US$96 compared with around US$105-109 at the height of last year's price crisis.
Nearby and deferred contracts have become almost entirely disconnected. Nearby prices are being driven by short-term supply disruptions and fears about escalating tensions with Iran. In contrast, forward prices remain anchored by estimates of the projected long-term marginal cost of producing sufficient crude to meet demand.
It is not the first time spot and forward prices have diverged in recent years.
Large disconnections occurred in 2005 and again in 2007 when long-dated futures failed to rally as fast as the spot market.
Market participants were slow to recognise the rise in oil prices was not just a temporary blip but reflected a step-change in emerging market energy demand and escalating exploration and production costs ("the end of cheap oil").
In 2009, another big disconnection occurred when spot prices sank in the midst of recession, while the forward market was supported by hopes of eventual recovery and the resumption of supply-side shortfalls.
The final set of disconnections were associated with the spike and subsequent fall in spot prices during the first half of 2011 caused by the Libyan revolt, which largely left forward prices unchanged, as the market judged (correctly as it turned out) that the interruption of exports would prove temporary.
Long-dated contracts are not necessarily a more accurate forecast of where prices are heading in future.
In 2005, and again in 2007, the long-dated market was slow to react to secular changes in the market, while nearby contracts adapted much faster. In contrast, nearby contracts over-reacted in both 2009 and 2011.
Long-dated contracts eventually fell into line with the spot market in 2005 and 2007. But in 2009 and again in 2011 it was the spot market that eventually converged back with forward prices.
Observers are sharply divided about whether the current divergence will be resolved by spot prices falling or long-dated prices rising.
If the recent rise in spot prices is entirely attributable to short term dislocations and a political risk premium, spot prices should fall back towards the long-dated average once the interruptions are solved and tensions either ease or are brought to a head.
If the spot market is really reflecting a prolonged supply-demand imbalance - of which problems in South Sudan, Yemen, Syria and Iran are merely the latest manifestation - then it is long-dated prices which will have to catch up.
Developing this theme, several prominent analysts argue there is good value in far-dated futures contracts, as their prices must eventually rise to reflect the still escalating costs of finding and producing oil in more challenging environments such as ultra-deepwater, as well as securing access to reserves in an era of rising resource nationalism and social spending in countries with large undeveloped oil fields.
While that argument remains popular among analysts, there is little sign of traction with investors, with forward prices struggling to rally.
Almost all the extra interest from investors is in short-term contracts, designed to capitalise on a short-term price spike, rather than a sustained rising trend. The pattern is distinct from 2008, when many investors were buying deferred contracts as much as five or even eight years forward.
If prices are spiking again, it is a different sort of spike to 2008, driven for the time being by (short-term) geopolitics rather than (long-term) fears about supply scarcity.
* By John Kemp for Reuters