Prior to OPEC’s Vienna Agreement last November, putting oil in storage because of its higher future value was a strong motivation for growing storage volumes. Now the curve is much flatter, and for oil priced three years in the future, that price is lower than the current one, providing a strong disincentive for putting oil in storage. Backwardation plays a significant role in oil producers’ decisions to hedge their production since they risk the potential of the price moving higher if the more traditional contango environment returns. As Rob Thummel, a managing director and portfolio manager at Tortoise Capital Advisors LLC put it, "What happens to the curve does depend on how the OPEC cuts will be carried out. The oil futures curve is indicating that the current OPEC cuts are here to stay for a while." U.S. oil producers will be very happy if that proves to be the case. While history would suggest otherwise, the pending (early 2018) initial public offering for Saudi Arabia’s state oil company, Saudi Aramco, an important component of its domestic economic restructuring effort, might force the country to hold its output down much longer than it has indicated. The reality may be that hundreds of small U.S. oil producers may screw up Saudi Arabia’s grand plan while hurting speculating oil traders with their record bullish oil price bet. A lower future oil price after a record bullish oil futures bet would be consistent with our recent history.

Eoin Treacy's view

Here is a link to the full report.

BP and Exxon Mobil spend a great deal of time and effort producing annual reports on energy use and issue predictions on how it will evolve over the time. That helps keep investors informed on how the companies plan to mobilise capital to take best advantage of how they see events unfolding. Saudi Arabia, as the world’s largest low cost producer, does not issue public annual reports. However its plans to IPO the company tell us more than any report ever could about the conclusions the Saudi Arabian administration has reached about the future of the oil market.

Disparities between the BP and Exxon on whether total automobile demand will peak in 2030 or 2035 are irrelevant to a sovereign like Saudi Arabia. They have to look at the truly long-term picture. The global population is still rising but the birth rate peaked nearly a decade ago which means population growth is now explained by higher survival rates and longer life expectancies. It might take 30 to 40 years but that lower birth rate will translate into fewer consumers around 2055 and then demand growth for transportation fuel will face a secular headwind. 

The Jevons Paradox dictates that our economy will become progressively more energy intensive; albeit in fits and starts. However, that does not mean gasoline will be the primary transport fuel. The energy density of batteries is doubling might only be about once every 5 years but over 30 years, provided innovation in new materials continues apace, batteries will be 64 times more energy dense than they are today. With that kind of energy density we could begin to think about range anxiety for gasoline cars rather than battery cars. 

Saudi Aramco would appear to have reached a similar conclusion and BP’s view  that there will be greater competition to develop resources over the next decade lest they be shut in forever makes sense. 

Against that background there is near-term potential for oil’s short-term range to be resolved on the upside because OPEC is currently cutting supply and economic growth is improving. However there are significant medium-term headwinds to high oil prices being sustained because so much additional supply becomes economic at higher prices.