Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 195

Future oil prices: it takes two to contango

The recovery in oil prices during the past year, as measured by the price of Brent Crude Oil, has provided a welcome respite for investors exposed to direct commodities, energy-related stocks and high-yield debt, particularly for North American shale oil producers.

While short-term predictions are fraught with danger, futures markets provide context as to where market participants believe oil prices should be over the medium term. This article provides a deeper understanding of oil pricing dynamics and the prospects for crude oil prices [Editor's Note: a 'contango' is where the futures or forward price of a commodity is above the spot price].

Forward curve dynamics

Futures markets provide an insight into the incentive pricing for producers, hedgers, and speculators to act. The spot price is typically quoted on news and business channels, but futures markets provide price points for multiple tenors in the future which can be used by market participants to either hedge production, hedge-pricing risk for buyers, or take a position, as is the case for speculators.

Further ‘along the curve’ (looking at prices that are at least six to 12 months in the future), there tends to be less noise and more signals which are reflective of market fundamentals. If this were not the case, there would be an opportunity to arbitrage for those investors able to participate in both the physical (spot) market and hedge using futures.

Brent Crude Oil forward curve fair value per barrel in US Dollars

The chart shows forward pricing for Brent Crude Oil as of 7 March 2017 (the ‘forward curve’, shown in red) and compares this to the forward curve one year ago (shown in grey).

The chart provides a number of insights:

1. Oil markets are back in balance

Since the announcement by OPEC in late 2016 of production limits, oil markets have been rebalancing. While this doesn’t negate the effect of currently high levels of global inventories, the forward curves illustrate how the forward curve has effectively shifted up and flattened. This is historically associated with positive performance for the immediate future as there is less incentive to produce today and forward hedge (prices are flat for the immediate future).

2. Shale picks up market share, ‘ROPEC’ picks up revenue

The wild card in the oil market deck is now North American shale oil production. A combination of recent increases in rig counts and falling marginal costs for certain oil basins mean that OPEC shares swing production with US shale producers.

Current pricing provides an incentive for more marginal production to come on line in the US, so this will likely translate into higher market share for shale as a percentage of global oil production, while OPEC and Russia (AKA ‘ROPEC’) benefit via increased revenues, albeit at lower production levels.

3. Aramco IPO in the balance

It is in the interests of the Saudi Arabians to maintain prices around these levels. With the proposed IPO of Aramco in the next two years, its oil assets would be priced at the average price of the past 12 months. A major objective of Saudi oil production would be to maintain pricing at these levels to keep them low enough not to encourage a major increase in shale production, but high enough to provide a reasonable valuation on oil reserves. The Aramco IPO could potentially make it the largest listed oil company in the world, above Exxon Mobil Corporation.

Conclusion on the oil market

Current oil market pricing in the mid-US$50 range is a ‘sweet spot’ for all major oil market participants, including OPEC, Russia and the more productive and cost efficient North American shale producers. Barring unexpected events, oil prices will likely remain range-bound for the medium term, with an effective floor of around US$50 as the base case. The abyss oil markets experienced in early 2016 provided an insight into the instability created by an oversupply in energy markets, and this will be front and centre to ‘ROPEC’ in encouraging strict compliance with production quotas.


Andrew Kaleel and Matthew Kaleel are Co-heads of Global Commodities & Managed Futures at Henderson Global Investors. This information is general only and does not take into account the personal circumstances or financial objectives of any reader.



Leave a Comment:



Oil does not have a supply side problem

The tipping point for investing in decarbonisation

Momentum or rupture: has demand for oil already peaked?


Most viewed in recent weeks

Welcome to Firstlinks Edition 433 with weekend update

There’s this story about a group of US Air Force generals in World War II who try to figure out ways to protect fighter bombers (and their crew) by examining the location of bullet holes on returning planes. Mapping the location of these holes, the generals quickly come to the conclusion that the areas with the most holes should be prioritised for additional armour.

  • 11 November 2021

Why has Australia slipped down the global super ranks?

Australia appears to be slipping from the pantheon of global superstar pension systems, with a recent report placing us sixth. A review of an earlier report, which had Australia in bronze position, points to some reasons why, and what might need to happen to regain our former glory.

Welcome to Firstlinks Edition 431 with weekend update

House prices have risen at the fastest pace for 33 years, but what actually happened in 1988, and why is 2021 different? Here's a clue: the stockmarket crashed 50% between September and November 1987. Looking ahead, where did house prices head in the following years, 1989 to 1991?

  • 28 October 2021

How to help people with retirement spending decisions

Super funds will soon be required to offer retirement income strategies for members in decumulation. With uncertain returns, uncertain timelines, and different goals, it's possibly “the hardest, nastiest problem in finance".

Tips when taking large withdrawals from super

You want to take a lump sum from your super, but what's the best way? Should it come from you or your spouse, or the pension or accumulation account. There is a welcome flexibility to select the best outcome.

“Trust your instinct” Hamish Douglass in conversation with Sir Frank Lowy AC

Sir Frank shares his story, including his journey from war-torn Europe, identifying opportunities, key character traits necessary for business success, and the importance of remaining paranoid yet optimistic.

Latest Updates

Investment strategies

20 punches: my personal investments are not a forecast

I prefer not to make market forecasts but I need to take personal investment decisions. I'm expecting a stockmarket fall in 2022 as central banks tighten policies but the mainstays in my portfolio will not be sold.


The good news about retirement income

A lower starting withdrawal rate doesn’t always mean living on less. The latest research on sustainable withdrawals offers flexibility for retirees to improve the chances of not running out of funds prematurely.


Three small companies expected to deliver big returns

Small caps might require more work than large cap stocks but they are often worth it. After all, all large companies were small once, and there can be clear benefits of investing in and backing management early.

5 new trends driving the future of biotech companies

The biotech industry has seen an explosion of new techniques which will lead to innovative areas of growth in the use of cells and genes as medicine. Money for funding life sciences and biotech pharma has soared.


Gold and inflation: what does history tell us?

Multiple factors have seen gold fall in 2021, despite the rise in inflation. But given gold has performed strongly across longer periods of higher inflation, gold may benefit under the current inflation outlook.

  • 8 December 2021

Solutions to unite the three pillars of retirement funding

Retirement solutions uniting the three pillars of retirement funding - the age pension, mandatory super and voluntary savings - are essential. Global experts discuss solutions that might work for Australia.

Investment strategies

New capital rules an effective vaccine for thriving banks

With stronger capital positions, improved brand equity and the potential to benefit from a robust post-pandemic recovery, the global banking sector is presenting significant opportunities for investors.



© 2021 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.