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    Backwardation for Brent is at $6.92 a barrel, the widest since 2013. What does this mean?

    Backwardation for Brent is at $6.92 a barrel, the widest since 2013. What does this mean?

    Backwardation for Brent is at $6.92 a barrel, the widest since 2013. What does this mean?
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    By CNBCTV18.com  IST (Updated)

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    On Friday, Brent futures settled at $90.03 a barrel, after touching $91.70 earlier, the highest level since October 2014. US crude prices soared to $86.82 per barrel, after climbing to a seven-year peak of $88.84 during the session.

    The six-month market structure for Brent crude oil futures reflects a “scarcity premium” that has been the widest this week since 2013. Known as backwardation, this premium is a sign of the tight oil market underpinning prices amidst a wider energy crunch.
    On Friday, Brent futures settled at $90.03 a barrel, after touching $91.70 earlier, the highest level since October 2014. US crude prices soared to $86.82 per barrel, after climbing to a seven-year peak of $88.84 during the session. As a result of tight oil supplies, backwardation for Brent reached $6.92 a barrel, the widest since 2013.


    What is backwardation?
    Backwardation occurs when a futures contract price is lower than the price for near-term oil delivery or the current spot price. When prices of futures contracts are lower than the spot price, traders are prompted to sell oil at the spot prices and buy the futures contracts for a profit. As a result, spot prices fall over time and this continues till it converges with the futures price.
    The opposite of backwardation is contango where the spot price is lower than the futures oil price. In contango, the prices of oil are expected to rise over a period of time.
    Why does backwardation happen?
    Backwardation can happen when the current demand for oil is higher than the future contracts. One of the reasons for the high current demand is a shortage of oil in the spot markets.
    What is happening in the markets now?
    The oil cartel Organization of the Petroleum Exporting Countries (OPEC) and allies such as Russia (OPEC+) have not raised their production levels, which is one the main factor underpinning the prices currently.
    One of the main factors underpinning prices at present has been the inability of major producers in the Organization of the Petroleum Exporting Countries (OPEC) and allies such as Russia to raise their production levels. The markets have also reacted to the attacks by Yemen's Houthi group on the United Arab Emirates and the possibility of a military conflict in Ukraine that could disrupt the energy markets.
    "So far there has been no supply disruptions in Eastern Europe, so guess the risk premium related to those tensions is not so high," Reuters quoted UBS analyst Giovanni Staunovo as saying. He added, "Some investors still prefer to hold their exposure."


    Scarcity premium
    In a report last year, Japanese bank MUFG had termed backwardation as a "scarcity premium," saying that the trend was likely to continue for now.
    "The blowout in Brent crude time spreads in recent trading days signals that the pathway (to) even higher oil prices remain firm," the MUFG report had said in October last year.
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