Russian Pipeline Shutdown Shifts Balance in Oil Market
by Dan Molinski, May 22, 2019
Contamination in the Druzhba pipeline has resulted in a premium on Brent for immediate delivery
The shutdown of a major Russian pipeline that sends crude to European refineries has fueled concerns of tightness in the global oil market, driving futures prices higher.
Problems with the Druzhba pipeline began in late April, when crude in the line was discovered to be heavily contaminated with organic chlorides. The issues have had an immediate impact on prices for Brent, the global benchmark for crude. In recent days, traders have been tacking on a premium of about $1 a barrel for immediate deliveries of oil compared with prices for crude to be delivered a month from now.
Brent futures for July delivery closed Tuesday around $72 a barrel, about $3.50 higher than the price being paid for Brent delivered in January 2020.
When near-term prices for oil are higher than later-dated prices, the price structure is called backwardation. Backwardation is often seen by investors and traders as a sign that higher prices are on the horizon. This is because traders become incentivized to sell oil right away rather than holding it in storage. Brent prices are already up 34% this year.
“The Russian situation is the main driver for the [backwardation] in the Brent curve,” said Rabobank energy strategist Ryan Fitzmaurice.
A commodity market in backwardation can draw in hedge funds and systematic traders who are looking to profit from the price difference in the contracts, according to Mr. Fitzmaurice.
U.S.-Iran tensions, turmoil in Venezuela, and continued production cuts by the Organization of the Petroleum Exporting Countries have also boosted Brent and may be supporting backwardation, he said.
Despite chatter that the Russian pipeline problem is being fixed, nothing has been fully confirmed yet, Mr. Fitzmaurice said.
In a report late last week, Fitch Ratings said European refiners may continue to see lower shipments “for the next few months” as the Druzhba pipeline is cleaned and restored to full operation.
“The reduced oil supply from Russia is likely to push the refineries to switch to other sources, including seaborne crude, which could be costlier,” according to the Fitch report.
Some analysts said in this case, backwardation isn’t necessarily bullish for the market as the problems caused by the Russian pipeline contamination issues are idiosyncratic, rather than a fundamental sign that a tight market will endure.
The price structure isn’t as developed in the market for West Texas Intermediate, the U.S. crude benchmark. Its front-month contract for June delivery closed Tuesday at $62.99 a barrel, only slightly higher than the contract for December, which stood at $62.49.
Matthew Smith, director of commodity research at crude tanker-tracking firm ClipperData, said WTI pricing is closer to normal partly because the Russian pipeline’s impact on U.S. markets is relatively minor. Also, fundamentals for the U.S. crude-oil market point to more-plentiful supplies, he added.
The Energy Information Administration reported last week that U.S. oil inventories stood at 472 million barrels, the highest since September 2017, while production remains near record highs above 12 million barrels a day.
“In the U.S., in contrast, you’re not seeing that front-end of the curve move,” Mr. Smith said. “Inventories are well-stocked, the market is being well-supplied from a production perspective, and pipeline expansions are coming online later in the year.”