The Oil Rally Is Running On Fumes

Submitted by Nick Cunningham at Oilprice.com

Oil prices have surged to two-month highs on growing signs of a rebound in oil demand, as the easing of lockdowns spread worldwide. At its peak in April, global lockdown measures affected around 3.9 billion people. But an estimated 3.7 billion people are now living in areas that are experiencing some version of a “reopening,” according to an estimate from Raymond James. 

Data from China has stoked some bullishness in oil markets, although there are some mixed signals. Traffic is back in many Chinese cities, and there are early signs that China’s oil demand is rising back close to pre-pandemic levels around 13 million barrels per day (mb/d). 

At the same time, a new coronavirus cluster in China suddenly sparked another lockdown measure. While Wuhan and other regions may be opening up, roughly 108 million people in Jilin province just went into lockdown. It’s a sign that the fight against COVID-19 will likely be frustrated by repeated flare ups in new cases, which may ultimately lead to renewed lockdowns. 

But for now, the markets apparently want to focus on the positive. On the global vaccine front, there appears to be some progress. Moderna said on Monday that its vaccine has shown to be safe in humans and has also demonstrated promising results in stopping COVID-19. Meanwhile, AstraZeneca said it could have 30 million doses of its vaccine ready by September.

Financial equities rejoiced, with the Dow Jones up roughly 3.5 percent during midday trading. WTI surged past $30 per barrel, up at one point on Monday by more than 10 percent. 

Massive supply cuts go even further in explaining the recent jump in prices. Oil traders view the implementation of the OPEC+ cuts favorably, with the 9.7 mb/d cuts phasing in swiftly. Part of the reason is that some oil producers, including Saudi Arabia, began having difficulty finding a home for its oil, so a portion of the cuts arguably became involuntary. 

Meanwhile, weeks of catastrophically low oil prices ravaged North American oil producers over the past two months. Shut ins could reach 2 mb/d in the U.S. by June, and Canada could lose 1 mb/d. 

But a reality check is in order. WTI at $30 per barrel is suddenly seen as “bullish,” but that price level is financially unsustainable for a vast swathe of global oil supply, including most of the U.S. shale complex. 

Moreover, the physical oil market is not “out of the woods” just yet, according to Rystad Energy. “We still see a 13.7 million bpd implied liquids (crude, condensate, NGLs, others) stock builds in May-20,” the firm said in a statement. That is down by half from the peak of the glut (-26.7 mb/d in inventory builds in April), but a significant overhang remains. 

Separately, Commerzbank argued that the oil market optimism may be running a little too far. “Despite all the euphoria, however, we believe that caution is still advisable: it will probably take some years before demand recovers to its pre-crisis level,” Commerzbank wrote on Monday.

U.S. Federal Reserve Chairman Jerome Powell warned that the American economy recovery could take until the end of 2021. “It could stretch through the end of next year. We really don’t know,” Powell said over the weekend. He noted that the economy might not return to normal simply because stay-at-home-orders are in the process of going away. “For the economy to fully recover people will have to be fully confident, and that may have to await the arrival of a vaccine,” Powell added.

In addition, the price rally may also be the result of speculative positioning – the physical market is trending towards rebalancing, but the rally can also be explained by overly exuberant speculative positioning. “Retail and institutional investors are also likely to have played a key part in the latest price rise. According to the CFTC, the latter expanded their net long positions in WTI on the NYMEX to around 352,000 contracts in the week to 12 May, putting them at their highest level since September 2018,” Commerzbank added. “Thus the positive trends (for the oil price) are largely expected and already priced in.”

The lockdowns are lifting, but there is nothing to suggest that the end of the pandemic is near, or that oil supply will remain shut in. “[T]here is significant downside risk related to two events, the resurgence in COVID-19 outbreaks, and deteriorating compliance to OPEC+ cuts as demand comes back,” Rystad warned.