‘Phantom liquidity’ at the dated portion of the forward pricing curve is misleading markets by skewing term pricing, and, ultimately, impacting the investment decisions of global oil projects and therefore the next cycle.
‘Phantom Liquidity’ or faulty term pricing
Traders traditionally mark curves at the close of each trading session by setting a mid-price, between the bid and offer for contracts throughout the futures curve. Liquidity in the term has deteriorated over recent years, thus the dated portion of the forward curve is what we call, ‘phantom liquidity’, or prices that appear to be reflective of a market that is not actually transaction based. Come execution time, prices can move sharply in either direction. This faulty term pricing phenomenon is particularly hazardous because it impacts global investment heading into the next cycle.
Lacking Visibility to Future Pricing
Higher cost global producers need good price visibility for long lead-time projects, yet they are unlikely to commit significant capital if forward pricing remains stuck in the low-$50/bbl range. Although US shale can fill the gaps of near term supply shortages, broad-based global decline rates become increasingly diluted with each additional US barrel that hits the market. RBC remains reasonably bullish, albeit ‘within a range’, amid doubts the forward curve can remain suppressed near current levels over the course of the next cycle. Also, even if the economics of previously unworkable projects like complex deepwater developments are becoming increasingly attractive, time is of the essence here because there are often many years separating investment decision from initial production.
Backwardated term structure: winners - and losers
RBC believes that low term pricing renders higher cost, longer dated non-OPEC projects less feasible, thus likely tightening the market over the next cycle. The winners? Short cycle shale projects and barrels from low cost, fiscally prudent OPEC producers and other relatively low cost operators like pockets of the Former Soviet Union who can capitalize by selling barrels on a spot or short-term basis. These regions will be in an ideal position to benefit from higher spot prices as reduced long-term visibility will favor lower cost projects. RBC argues that we are moving into a vicious circle where significant backwardation breeds further backwardation and warns that the situation will worsen when heavy hedging programs come to market from shale producers, or if National Oil Companies initiate financial hedging strategies.