The attack on Saudi oil installations is still not a too distant memory. It happened over a weekend and the gut reaction of the market pushed oil prices more than $10/bbl above the previous Friday’s settlement level. The rally, however, did not last and Brent closed almost $3/bbl off the day’s high and never went back up again. Yesterday the oil market behaved in a very similar but reverse fashion. The Saudi decision over the weekend to cut prices and increase production sent oil prices into a tailspin. WTI crashed below $28/bbl in the early hours of yesterday’s trading and Brent fell $14.25/bbl below Friday’s close. The market started to recover from these lows and the two main crude oil futures contracts settled more than $3/bbl higher than the lowest prints. Still, WTI and Brent both tanked more than $10/bbl with the former settling at $31.13/bbl and the latter at $34.36/bbl. Some Canadian grades broke below the $20/bbl barrier!

Is it possible that what we saw yesterday was the exact opposite of last September’s market reaction and a bottom has been found for months to come? The answer to the question is a plausible no. Six months ago the kingdom rushed to reassure the market that the missing barrels would be quickly replaced from storage. The market correctly bought into the argument. This time around Saudi Arabia made it clear that once the hatchet was dug up it is more than happy to go into battle for what it considers its fair share of the market. Traders and financial investors will probably believe the kingdom once again.

If this is the case, where is the bottom? Strong arguments emerged yesterday that a sharp, vicious and violent fall to the $25-27/bbl area is not something that is to be dismissed. Firstly, technical analysts are pointing to the lows of 2016 as the next strong downside objective. These are $26.05/bbl on WTI and $27.10 on Brent. Secondly, the IEA chief, Fatih Birol believes that an oil price below $25/bbl would trigger a halt in shale developments. Thirdly, investment banks cut their 2Q oil price forecast in the light of recent developments. They vary but are around $30-$35/bbl with possible dips below the lower of them, potentially down to $25/bbl. Fourthly, the Russian finance ministry is confident that the country could weather oil prices at $25-$30/bbl for 6-10 years by tapping into the National Wealth Fund. Curiously the very same ministry said last Thursday that Russia was prepared for lower oil price if supply talks broke down. They did. There is a growing consensus around the $25/bbl oil price level. It remains to be seen whether it turns out to be realistic but the latest monthly data from the IEA certainly supports this view.

Demand contraction

In its report the IEA confirmed what the market has suspected. The outbreak of the coronavirus has seriously dented global oil demand and global oil demand growth. Consequently, the call on OPEC has been revised significantly down and now global stock builds are all but guaranteed for this year. It will not come as a surprise either that the first half of the year will be more severely affected than the second half. Of course, the latest IEA estimate is just a snapshot that is based on the current situation. If the coronavirus cannot be contained in the foreseeable future further deterioration in the oil balance can be anticipated and vice versa. For the time being we can pencil in the first annual global oil demand contraction since 2009.

In its overview the IEA points to the deteriorating global economic growth caused by the Covid-19 virus as the main reason for the downward revisions in global oil demand. It uses the 0.5% reduction in global growth estimate by the OECD at the beginning of the month as the basis for the oil demand cut. The OECD lowered its global GDP projection for 2020 from 2.9% to 2.4%. Whilst the agency emphasizes that data are far from complete, the first quarter of the year has seen a drop of 2.5 mbpd in global oil demand compared to the same period of 2019. This contraction includes a drop of 4.2 mbpd last month, “of which 3.6 mbpd was in China”.

It is usually a useful exercise to compare the latest supply and demand estimates with that of the previous months. Given the severity of the coronavirus outbreak it makes more sense to recall what the IEA predicted back in December and measure those figures against the latest available data series. In December, 2020 global oil demand was set to stand at 101.50 mbpd. The latest report shows a fall of 1.60 mbpd to 99.90 mbpd. The first half of the year is the more severely affected. At the end of last year thirst for oil was expected to be 100.45 mbpd. The epidemic, however, has cut this estimate by 2.50 mbpd to 97.95 mbpd. It is worth noting that the quarterly break down is 96.70 mbpd and 99.20 mbpd implying that the worst will be behind us during the present quarter, at least as far as demand is concerned. In case the virus is not contained in the foreseeable future additional downward revisions are anticipated in next month’s report.

The significant reductions in global oil demand led to significant cuts in the call on OPEC. Three months ago, the 2020 OPEC call was forecast to be 28.90 mbpd – 28.40 mbpd in 1H and 29.40 mbpd in 2H. The latest report puts the annual number to 27.30 mpbd – 25.95 mbpd in the first half and 28.65 mbpd in the latter six months of the year.

These revisions clearly show why the weekend’s standoff between Saudi Arabia and Russia led to the bloodbath. If we use the latest (February) OPEC production estimates of 28.34 mbpd global oil inventories will have grown by 3.34 mbpd in 1Q and will build at the rate of 1.44 mbpd in 2Q. This is the optimistic approach. As Russia refused to sign up for the next round of supply cuts and Saudi Arabia retaliated by cutting official selling prices and suggesting ramping up production from April this figure is just simply unrealistic. The same way as it is impossible to pin down demand destruction, supply forecasts are also just guestimates. One approach (rather conservative) is to assume that OPEC members with quotas will return to the October 2018 production level of 26.75 mbpd. Add to that the 3 mbpd combined output from Iran, Libya and Venezuela and you will end up with a level of 29.75 mbpd. Non-OPEC members of the OPEC+ group could add an extra 0.8-1 mpd production and what looked like a 1.44 mbpd build in global stocks for 2Q of 2020 all of the sudden becomes an increase in the region of 3.4-3.6 mbpd.

When oil prices hit the aforementioned lows at the beginning of 2016 the quarterly oil balance was 1.50 mbpd – a total demand of 95.00 mbpd against a global supply of 96.50 mbpd. The global stock build is much higher this quarter and the situation is unlikely to improve significantly in 2Q. Although oil is correcting upwards this morning -it is some $2.50/bbl above last night’s settlement at the time of writing- this optimism is based on expectations of fiscal and monetary stimulus. Of course, this retracement might continue in the short-term but it is not expected to last. The Fed’s rate cut last week failed to provide meaningful support for risky assets. There is no reason to believe that fiscal stimulus would be more successful in the fight against an epidemic or pandemic. The two most important variables, virus containment and the thawing of tension between Russia and Saudi Arabia, can and probably will reverse the current trend but such a change of fortune is currently not imminent.