Oil traders are scratching their heads.

On paper, their supply and demand balances indicate that the market is at a surplus; and prices should be heading down, with physical differentials weakening and inventories building.

Yet, in reality, it is the opposite. Oil prices are rising – Brent has hit a six-month high this week – and signs of physical tightness are emerging, with price differentials in physical grades strengthening.

So, what is wrong? The view among physical traders is that the supply and demand balance numbers are incorrect. Demand is low on paper but physical traders feel it is higher, particularly in emerging countries in Asia, east Africa, Latin America and the former Soviet Union.

The energy market, however, focuses on developed countries, with most of the data coming out of the US, where consumption continues to fall on a year-on-year basis.

Supply, on the other hand, is running lower. The market has lost 350,000 barrels per day of crude from South Sudan; Iran is also exporting less, the Buzzard oilfield in the North Sea has problems again and the recovery of Libya’s crude oil output has stalled since December. Moreover, the promised large increase in Iraq exports of crude oil has yet to materialise.

In a clear sign of the supply-demand tightness, the price of Brent crude has jumped. The global benchmark hit $118.17 a barrel on Thursday, the highest level in six months. The shape of the crude oil curve has also improved, with prompt contracts moving into a significant premium to forward contracts. In early January, the crude curve was almost flat, with the prompt contracts briefly falling below forward contracts.

And Brent is not alone in its ascent. Urals, the Russian benchmark, is trading now at a premium to Brent, re-enacting the situation seen during most of last year when refiners in the Mediterranean raced to replace the barrels lost from Libya. The premiums of other crudes, such as Azeri Light or ESPO, have also surged, suggesting that the physical market is tight across the board.

On paper, the supply and demand balances suggest that the first quarter should see a counter-seasonal build-up of crude oil inventories, the first in eight quarters. But in reality, the physical market is suggesting that the world continues to draw down stocks.

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