Any trending market is susceptible to retracements, and intriguingly, most asset classes reversed course simultaneously yesterday. The most remarkable turnaround came from gold, which shed nearly 6% of its value after rallying more than 30% in just two months. There was no clear explanation for either the timing or the magnitude of the decline, though events from yesterday offered a plausible rationale.

One possible factor is the upcoming Trump-Xi summit, from which the U.S. President is expecting a fair trade deal. A similar fate could await the stock market, although yesterday’s modest pullback should be seen as a minor setback rather than a sign of a broader trend reversal, given that corporate earnings remain reassuring.

The equally modest rebound in oil prices was led by Heating Oil, following forecasts of a drop in distillate stocks last week. As it turns out, the draw of 1 million bbls was less than the crude plunge of 3 million bbls, as reported by the API, helping prices rally further overnight. Another driver was the fragile Middle East ceasefire that needs further and rather significant US nursing, while the apparent cancellation of the Trump-Putin meeting in Budapest suggests that no peace, not even a tentative one, is forthcoming in Ukraine. Reciprocal attacks on energy infrastructure are likely to continue unabated.

Additionally, a Bloomberg report that the U.S. intends to purchase 1 million barrels of crude for December and January delivery into the Strategic Petroleum Reserve contributed to the rebound. The joint Qatari-US warning to the EU to reconsider sustainability rules or face the consequences of unreliable LNG supply from the two exporters is an additional factor in this morning’s price jump. Rising supply, which sent prices to a 5-month low in October, has been overshadowed by political maneuvering but will probably make a reappearance soon.

Is Contango Here to Stay?

One of the most profound changes in our market in recent times has been the palpable weakness in the crude oil structure. For our purposes, we are concentrating on the European benchmark; however, given the interconnectedness of the various crude oil markers, the trend is similar across the world. The collapse in backwardation stands in stark contrast to the optimism prevailing in equity markets. It implies that the shift in sentiment is more a function of supply-side developments than demand, although the stuttering Chinese economy has likely played its part in souring the mood.

My colleague argued in yesterday’s report that the fundamental reason for the weaker crude oil structure is the growing volume of oil at sea seeking a home. This, in turn, stems from the U-turn in OPEC+ policy. Market share is now the priority, at the expense of a tighter oil balance. In addition, resilient US crude oil production, the resumption of Kurdish oil flows via Turkey, and possibly rising Venezuelan exports are all contributing factors. Geopolitical risk is being ignored, although continuous and successful Ukrainian assaults on Russian energy infrastructure are reducing product exports while increasing crude shipments, another apparent factor behind the current abundance of crude oil.

The weakness is clearly manifested in the spectacular collapse of the M1–M7 Brent spread, which has fallen from over $6/bbl in mid-June to a contango of 40 cents/bbl as of Monday’s settlement (although it has rebounded yesterday and this morning in tandem with outright prices). Physical Brent, which commanded a premium of $2/bbl over forward contracts only a few months ago, is now offered at a discount.

Undoubtedly, the market has been weak, and given the close relationship between outright prices and structure, it is also mirrored in the former trading around a five-month low before the retracement began. If one subscribes to the view that the flat price chiefly reflects the thinking of financial investors, while the structure mirrors sentiment in the underlying physical market, then it is tempting to conclude that the two are neatly aligned.

This harmony will plausibly persist as long as global and regional inventories are projected to swell. The latest set of monthly reports paints a gloomy picture, particularly from the EIA and the IEA. They project global oil inventories to grow by 2.59 mbpd and 3.6 mbpd, respectively, in the current quarter. According to their estimates, the first quarter of next year will see an even greater oversupply, with excess production of 2.75 mbpd and 4.70 mbpd, respectively. Even OPEC, the ardent optimist, while it expects global stocks to decline by 200,000 bpd in the October–December period, foresees a build of 1.30 mbpd in 1Q 2026.

Will the current outlook be subject to sudden or gradual revision? History suggests that prolonged and steep contango is usually triggered by unexpected events. Over the past 18 years, three such episodes have been recorded. The demand destruction caused by the 2007–2009 financial crisis and by the 2020 pandemic sent both outright prices and spreads tumbling, with the M1–M7 Brent differential falling below -$10/bbl on both occasions. Conversely, the three-year contango observed between 2014 and 2017 was precipitated by an OPEC-induced supply war, which US shale producers ultimately won.

The question that now needs to be asked is whether there is any real possibility of significant demand destruction or an unstoppable surge in supply. In these uncertain times, marked by isolationism, growing anti-globalisation sentiment, and brewing trade wars, recession risks can never be ruled out. However, at present, there are no tangible signs of such a downturn, and oil demand forecasts remain broadly sanguine. The recent increase in oil supply cannot be repudiated, but a full-scale supply war, notwithstanding OPEC+ efforts to reclaim voluntarily surrendered market share, appears neither imminent nor likely. To cite a well-worn mantra, the cure for low prices is low prices. The longer oil remains depressed, the less inclined the producer alliance will be to continue expanding output. Unless prices recover, US shale producers will inevitably come under strain, and there may come a point when the US administration pressures Middle Eastern suppliers to curb production.

Finally, it is worth remembering that global spare capacity is on the decline, raising the anxiety level of genuine shortages should an unforeseen and severe supply disruption occur. While contango has been the defining feature of the oil market, its role may ultimately prove to be a short-lived cameo. The current upside correction will probably be followed by renewed weakness both in outright prices and in structure, but the downside potential is expected to be restricted.

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