Rallying spot oil prices lead the curve into backwardation 

United Arab Emirates -  January 19, 2021:    The Brent crude oil curve has firmly flipped into backwardation. Expectations of large oil inventory declines in the months ahead have grown on an extension of OPEC+ cuts into 1Q21 and the distribution of a number of Covid-19 vaccines. The flip side of crude oil markets going into backwardation is that, while spot oil prices have rallied, long-dated Brent and WTI prices are now lower than they were in June last year, keeping a lid on new investment. Also, while new virus strains in the UK and other locations have led to more lockdowns, fuel substitution is likely supporting oil demand too. One example is Asian spot LNG cargoes recently trading at $195/boe on robust winter demand. Because of this, oil is trading at a record discount to LNG and gas-to-oil switching could exceed 1mn b/d over the next month or two. Also, financial factors such as the DXY weakening from 94 to 90 since early November have played a role in driving oil higher.

A broad range of commodity prices is spiking up abruptly
Excess liquidity too has visibly made its way into risky assets like equities, setting up another tailwind for oil. While some service-oriented segments of the economy like the hospitality sector remain in recession, many sectors producing industrial or consumer goods are booming. From corn to iron ore to thermal coal to copper, a combination of supply constraints, high liquidity, and robust demand has pushed a range of commodities to the highest price levels in almost a decade. In this context, perhaps it is not surprising that Brent prices have gotten close to our mid 2021 $60/bbl target well ahead of schedule. Still, global spare oil production capacity is near record levels with 8mn+ barrels of OPEC+ capacity offline. With a clear risk of new lockdowns ahead due to the new virus strains and refinery crude demand set to ebb off seasonally, we see limited upside to crude oil prices in the very near-term. 

As vaccines are rolled out, oil could overshoot too
Still, a swift recovery in global mobility could create a substantial oil deficit in 2021 as herd immunity takes hold across a major economies. Many of the Covid-19 travel restrictions could be lifted in 2H21. The rapid steepening of the fixed income curve in the US following the Democratic sweep in the Georgia run-off election also points to an acceleration in US economic growth ahead. With democrats now in control of Congress and the White House, another big US fiscal stimulus in the spring could boost the US economy and commodity prices alike in 2H21. Admittedly, increased mobility, more fiscal stimulus, and continued monetary easing could all combine to push oil above the $60/bbl mid-2021 target we introduced back in June 2020 (see The third time's a charm for oil). So even if oil is ahead of the curve at the moment, we acknowledge prices could easily overshoot our projections heading into the summer.