The performance of the recent past suggests that the validity of the current uptrend will not be questioned just because prices fall one or two days. For the last eight months the market has hardly ever registered three consecutive daily losses and this observation is fitting this week, too. Monday’s sell-off was followed by renewed weakness in the early part of Tuesday’s trading from which the oil complex recovered impressively and it built on it yesterday.
The resumption of the move higher was aided by the US Weekly Petroleum Status Report. It is not necessary to dig deep into the numbers to acknowledge why the reaction was positive. If one accepts that this year’s bull market is the product of rising demand and slimming stocks, then the latest weekly US stats are the perfect reflection of this phenomenon on a regional basis. Because of the 6.7 million bbls draw in crude oil inventories commercial stocks fell by 4.6 million bbls and they show a 3.1% deficit to the 5-year average. (Gasoline inventories built by 1.5 million bbls but distillate stocks fell 900,000 bbls.) Consumption has risen to just below 21 mbpd, the highest weekly reading since March 2020. Equity markets remained stable and near their all-time highs as the US private sector added 692,000 jobs in June helping oil to firm. The current optimism is best mirrored in the strengthening backwardation of the two main crude oil markers. The September/October Brent spread shot up 10 cents/bbl yesterday’s whilst September WTI commands a premium of more than $1/bbl over the October contract.
Unabated recovery through the first half
Those who wagered on irreversible economic recovery at the beginning of this year based on perceived widespread inoculation programmes feel entirely vindicated now that the first half of 2021 has passed. After the BioNTech/Pfizer announcement at the beginning of November, others shortly followed suit and although the launch of different vaccination campaigns was anything but smooth the general feeling is that the virus will be defeated. The numbers speak for themselves. Both registered daily cases and death rates are on a downward trajectory ever since the last peak back in April and although regional flare-ups will be the feature in coming months the exponential increase in vaccinations administered ensures that mobility restriction will be lifted step by step.
Of course, the revival of the global economy was not exclusively the function of vaccinations. Massive fiscal and monetary stimuli worldwide also provided a welcome impetus. The trailblazer has undoubtedly been the US. After occupying the White House, Joe Biden did not waste much time to get through the first of his three economic packages and he signed the $1.9 trillion relief bill into law at the beginning of March. Last week he struck a bipartisan agreement for the $1.2 trillion infrastructure deal that will provide additional boost for the US economy and now he is eyeing the last piece of his immediate economic agenda. It is the American Families Act, an anti-poverty package that would provide funding for education, transportation, and climate change.
The double-impact of vaccine roll-outs and stimulus measures made equities an irresistible investment tool for institutional as well as retail players. Their confidence in the global economy is reflected in the 14% gain in the S&P 500 index and the 11% return the MSCI Global Equity Index produced in the first half of the year. The stellar performance, however, has also carried ominous signs. As financial data pointed to a protracted period of economic well-being the voices of those crying inflation have become louder. There is a tug-of-war between policy makers who argue that inflationary pressures will be transitory and analysts and investors, some of whom urge an early interest rate increase to prevent the economy from overheating. The current view is that the Fed will start easing in 2023, a year earlier than originally anticipated if, and it is a big IF, the labour market justifies it. In anticipation of futures rate increase the 3-year US Treasury yield has risen from below 0.17% at the end of last year to 0.45% yesterday.
Of course, when stock markets are flying oil demand also grows. The 5.73 mbpd improvement in 1H 2021 from the comparable period of 2020 is spectacular but at the same time can be somewhat misleading – after all last year’s base line was the lowest for decades (OPEC data). What is intriguing to observe is that the eye-catching flat price rally that sent both WTI and Brent around 50% above the end-2020 price level has not been coupled with more optimistic demand view. In December 2020 OPEC put the 1H 2021 demand estimate at 94.82 mbpd, this month 720,000 bpd lower. Demand for OPEC oil that was seen at 26.92 mbpd six months ago is now forecast to be 26.25 mbpd.
So why the persistent optimism despite the constant downward revisions in global oil demand and OPEC call? Well, firstly, the market is forward looking. It expects further improvements in global oil demand. If the latest OPEC report is to be believed during the second half of the year the world will need 4.18 mbpd more oil than in 1H. Secondly, although it is easy to resist everything but temptation, the producer group, together with its ten allies, has not gotten carried away. Despite the rise in oil prices, they have always tapered output constrains by the right amount or even below that. The combined monthly production of member countries has always been below the demand for their oil. This has ensured constant and significant stock depletion. OECD commercial oil inventories that peaked at 3.212 billion bbls in 2Q 2020 have been trimming ever since. After finishing 2020 at 3.036 billion bbls they have dropped to 2.968 mbpd by the end of 1Q 2021 and are likely to fall below the 5-year average (the 2015-2019 average, that is) shortly.
The recovery is expected to continue in the latter part of the year. As more people are vaccinated and the virus is tamed mobility restrictions ought to be eased gradually all over the world. This will result in continuous expansion, which is a blessing for oil consumption. In other words, in the first half of the year the stage has been set for further improvement, and for economic and oil demand growth. This upbeat outlook will only be in jeopardy in case of a.) stimuli withdrawal and interest rate increase due to rising fears on inflation and b.) the OPEC+ group opening the spigots or being unable to accommodate eventual Iranian barrels if or when the nuclear accord is revived.