Funds prepare $2 bn oil market play as supply tightens

Passive investment funds are poised to shift an estimated $2 billion from far-term to near-term crude futures over the next week, anticipating an energy market rally as a historic Organization of the Petroleum Exporting Countries  (Opec) output cut slashes supply. 

The switch may foreshadow the end of a global oil glut that built up during a two-year price war. 

On Friday — for the first time in six years — a rule in one of the most popular commodity market indices was triggered, requiring funds tracking the index to sell Brent crude futures contracts for December and to buy contracts for June . The S&P GSCI Enhanced Commodity Index rule aims to ensure that investors are positioned to cash in when oil market fundamentals change  in this case, when supply becomes so tight that the current price of oil becomes higher than the price of oil for delivery many months or years into the future. That structure is called backwardation. 

When markets are oversupplied, the opposite is true: It is cheaper to buy crude now than to buy it for delivery later. That structure is called contango. 

An S&P bulletin late Friday confirmed the rule had been triggered for Brent contracts. It stipulates that the funds must bring their money forward if the second and third month contract settles at a difference of less than 0.5 per cent on the third to the last day of any given trading month. 

On Friday, the Brent May contract price settled at $56.31 a barrel, while the June price settled at $56.55 a barrel. That would make the difference about 0.4 per cent.  The threshold was not breached for West Texas Intermediate crude. 

Investors will need to start the shift on March 1 and complete it over the next five business days, moving 20 per cent of their money each day. Two traders with knowledge of the indices told Reuters that they estimated that rule impacts between 35,000 and 45,000 Brent contracts. 

Each contract represents 1,000 barrels. So if those predictions prove true, about 40 million barrels, worth about $2 billion, will change hands. 

“This is just another reason to be very bullish” about oil prices, said one trader involved with the deals, who spoke on condition of anonymity.