One of the largest oil supply overhangs in North Sea history has driven prices lower and prompted crude traders to chase more Asian buyers.

The price differential of global benchmark Brent North Sea crude fell to its lowest level in 10 years earlier this month, suggesting that while the market is starting to show signs of strength as demand ticks higher, the global surplus has some way to go before clearing.

On July 16, Royal Dutch Shell plc offered a Brent cargo for a June 26-28 loading at Dated Brent minus $1.40 per barrel (bbl), down 40 cents from a day earlier. That was the lowest Brent differential recorded in Reuters pricing data going back to 2005.

Although Brent remains near $64 per bbl—from around $45 per bbl in January—a surplus of unsold North Sea and West African (WAF) crude cargoes has been pressuring the physical crude market.

“The amount of crude oil afloat on the water off the coast of the U.K. is increasing and that is putting considerable pressure on the North Sea price structure,” Petromatrix Oil Analyst Olivier Jakob told DownstreamBusiness.com (DSB) recently.

Output of the North Sea’s largest crude stream, Forties, has been higher than expected, resulting in extra cargoes being added to the June loading program. At the same time, other cargoes have seen their loading dates brought forward.

According to Jakob, as many as four VLCCs (very large crude carriers) could take North Sea crude oil to Asia this month—more than in previous months.

That still may not reduce the excess.

Off the coast of West Africa and in the waters of the North Sea, supertankers holding million barrels of oil have essentially become accidental storage as their owners seek customers.

The vessels are competing with new loadings, as well as time-chartered cargoes that major trading houses such as Trafigura and Unipec booked to store crude months ago and are now selling.

“The absolutely dire West African (WAF) crude balances have finally weighed on Brent time spreads, with the contango out to January 2016 widening out, amid extensive liquidation,” observed Amrita Sen, co-founder and chief oil analyst at U.K.-based energy market consultancy Energy Aspects June 23.

With rising volumes of distressed Nigerian cargoes on water, European land storage completely full and European refineries full up through to mid-late third-quarter (3Q) 2015, Sen said Brent had to fall in relation to other global grades.

“This has opened up the Atlantic Basin arbitrage to both the U.S. and the Far East. There is a lot of crude to clear, so any quick recovery in Brent spreads is unlikely,” she noted. “This has implications for both U.S. and Asian crude grades.”

Strength in domestic crudes will attract much of the Atlantic Basin overhang, potentially dampening the rate of summer-inventory drawdowns in the U.S. ahead of the fall refinery-maintenance season.

But once the imports materialize, a wider spread between Brent and U.S. benchmark West Texas Intermediate (WTI) and weaker fourth-quarter (4Q) 2015 WTI spreads could be in the cards, even if both head higher first, Sen explained.

“In the end, while a collapse in the Brent curve is keeping refining margins elevated despite a weakening in distillates, crude prices are unlikely to move higher in 3Q 2015, as the current crude overhang will take time to clear and production declines will not be visible before 4Q 2015,” she added.

Even before the latest round of distressed Nigerian cargoes, the weakness in Brent spreads has been long coming. Some market observers, including Sen, remain surprised as to why it took so long.

“At least part of this correction should have happened in April, or in May at the latest, as WAF started to significantly diverge from the rest of the world,” Sen further noted. “Some of the WAF weakness was clearly linked to specific issues, namely the lack of demand for lighter grades. But ultimately, distressed WAF cargoes have to be cleared in Europe.”

Unwinding Contango Trade

The physical market for crude oil remains will remain under pressure as traders unwind profitable storage plays after several months that that saw them holding millions of barrels on tankers at sea, according to BMI Research in London.

“As the contango in the Brent futures market narrows, the monthly cost of carry for floating storage volumes will increasingly dwarf inter-month price spreads. We calculate that an average of 205,000 bbl/d [barrels per day] of crude will be released from floating storage for the remainder of 2015,” BMI analysts wrote May 1. “This will put sustained downward pressure on Brent, and cap any sharp upswing in the price.”

The release of floating oil volumes will introduce additional supply into an already saturated market and exacerbate the number of unsold Mediterranean, North Sea and West African cargoes in the Atlantic Basin.

“When the contango started, it created a demand,” PVM Oil Analyst Tamas Varga said. Now “they are creating additional supply.

“The structure of the market should weaken significantly,” Varga told DSB June 26. “There is just a lot of oil around in the U.S. and globally.”

Oil prices collapsed by 60% between June 2014 and January 2015, driving the cost of oil for prompt delivery to well below future prices and making it profitable to purchase oil and store it to sale at a later time.

At its peak earlier this year as much as 50 million barrels (MMbbl) of oil was estimated to have been earmarked for storage on tankers, according to Varga. The oil market has since rallied—narrowing that discount, or contango, and prompting traders to cash in on profits.

Varga estimated that volumes earmarked for contango-led floating storage had dropped to about 10 VLCCs—each capable of carrying a maximum of 2 MMbbl—for a total of 20 MMbbl.

Contango trade is profitable if the spread is wide enough to cover the costs of holding crude oil stocks—namely storage and working capital. Such stocks are discretionary stocks built or drawn in response to prices, especially the forward price curve.