Financial investors have added exposure to crude oil as a result of the tightening oil market and to benefit from higher roll returns, with the futures curve now more strongly downward sloped, according to a UBS report.
With crude oil prices rising to the highest level since November 2022, “we expect Brent to trade in a range of $90-100 a barrel over the coming months, with a year-end target of $95 a barrel,” said Giovanni Staunovo, strategist at UBS Chief Investment Office, Global Wealth Management.
Global visible oil inventories (crude and refined products) fell sharply by 76.3 mln barrels in August and are now standing at the lowest level since July 2022, according to the International Energy Agency.
Most of the drop came from oil on water (down more than 50 mln barrels), but even on-land inventories fell by around 24 mln.
“The strongly undersupplied oil market in August is the result of solid oil demand and lower supply from Saudi Arabia and the other OPEC+ countries over the recent months,” the UBS report said.
The market tightness is also visible in crude oil time spreads, which is the price difference between the first futures contract and the one of the subsequent months, with the futures curve now more strongly downward sloped, known as ‘backwardation’.
“Tellingly, Brent’s six-month contract is about $5/bbl cheaper than the first-month contract, up from a discount of $0-1/bbl during 1H23.”
The UBS report added that this backwardation structure is likely drawing investors into oil, as they can benefit from rolling one contract to the next.
Net length in Brent and WTI futures and options contracts has bounced to the highest level since November 2022 from extremely low levels in 1H23,” it said.
“While we expect only modest upside from current prices, we reiterate our recommendations for risk-taking investors to add long exposure via first-generation indexes or longer-dated Brent contracts, or to sell Brent’s downside price risks,” Staunovo concluded.