Commodity markets will probably stay in a “holding pattern” until there are hard data showing real demand and shrinking stockpiles to support the recent price rally, according to Goldman Sachs Group Inc., which expects such evidence to emerge in the second quarter.

We are confident that real activity and inventory draws are likely to materialize,” the bank said. “In oil, the U.S. will be the last to draw” and global fundamentals suggest a much stronger market than U.S. stockpile increases suggest, it said. In China, the virtuous cycle created by rising producer prices has more to run and strong credit data will boost commodities.

It is also possible for the curve representing the term structure to have an upward slope over some future delivery periods and a downward slope over others. This often happens with commodities that experience large seasonal swings in production (e.g. grains) or consumption (e.g. natural gas), but it can also happen with other commodities.

term-structure

If a market is in “contango” then the later the delivery month, the higher the price, resulting in the chart of the term structure being an upward sloping curve. If a market is in “backwardation” then the earlier delivery months will have the higher prices and the term structure will be represented by a downward sloping curve.

Due to the attractive arbitrage opportunity that would be presented by backwardation, it’s a situation that will usually arise only if there’s a shortage of currently available physical supply. Backwardation, or a downward sloping term structure curve, is therefore a clear sign that the physical market is tight

Sometimes the term structure curve will have a steeper upward slope than usual, that is, the later delivery months will trade at larger-than-usual price premiums to the earlier delivery months and the spot price.

(…) a term structure curve with a sustained steeper-than-usual upward slope indicates an abundance of currently available physical supply

Looking at the “term structure” charts displayed above, it is apparent that the fundamental backdrop is currently supportive for the oil price.

Investors have amassed a record number of bullish bets on oil, but market fundamentals have yet to catch up with their optimism—putting oil prices at risk of a large fall, analysts say.

However, other indicators show the market has some way to go to shake off the massive glut that has depressed prices for more than two years. The U.S. Energy Information Administration said Wednesday that U.S. crude stockpiles rose to their highest level in the week ended Feb. 10 since the collation of data began in the 1980s.

The U.S. stock build sends a cautionary signal to the market at a time when stocks should be starting to decline, rather than build.

Such high compliance largely reflected OPEC kingpin Saudi Arabia bearing a disproportionate share of the burden, which looks unsustainable.

The latest deal is an admission that letting the market decide things was inflicting too much pain on OPEC economies and not enough on U.S. producers.

OPEC’s fundamental problem is that many of its members are unable to deal with the inherent cyclicality of the oil market. A true cartel would dominate oil production and have both a cushion of spare capacity and seamless coordination to iron out fluctuations in supply and demand. OPEC has none of these things.

Indeed, as energy economist Phil Verleger wrote in a report published this weekend, the glut of oil inventories OPEC aims to eradicate reflects the market at work, as excess barrels are bought by traders able to lock in profits by selling them forward. This inventory, maintained by market forces, is the market’s cushion now, keeping prices remarkably stable, not OPEC’s nebulous spare capacity.

Financial Post: OPEC deserves no better than ‘C-minus’ on production cuts as global glut endangers price recovery

The short-lived recovery of world oil prices is already in danger as OPEC and Russia fail to deliver on agreed output cuts and America’s shale industry roars back to life.

Evidence from shipping data suggest that cuts are nowhere near the 1.8 million barrels a day (b/d) pledged by OPEC and 11 non-OPEC states in November.

“By our estimates non-OPEC compliance was just 40 per cent in January, and that is not enough to curb global oversupply. All hell is going to break loose if they don’t extend the deal beyond June,” said Tamas Varga from brokers PVM Oil Associate

Varga said Russia had promised to trim output by 300,000 b/d but has only delivered a third of this figure so far, pleading for more time.

The U.S. bank said its own sources do not confirm OPEC claims of compliance. Four countries are actually increasing output above their reference levels, including Iraq, Venezuela, Algeria, and the Emirates.

Productivity per rig has soared tenfold or more since 2010. “Results are astonishing, with steep increases every month in all the major shale basins,” he said.

Bank of America expects shale frackers to add 600,000 b/d this year, vastly complicating OPEC’s task.

The real concern is China, the new giant in the global crude markets. The Chinese economy is starting to slow again as authorities tap the brakes after another credit-driven boomlet, raising interest rates and tightening fiscal policy. Car sales fell by 16 per cent in January.

The property market is rolling over in the big cities of the eastern Seaboard. China has been cutting the energy intensity of its economy by an average of 4.5 per cent annually over the last four years as it switches from breakneck industrialization to a more mature service economy.