Last week’s OPEC+ stalemate did not exactly dent the underlying confidence, but it certainly made investors cautious. The initial rally that greeted the fallout between the United Arab Emirates and Saudi Arabia was quickly overtaken by worries of a potential supply glut. These concerns, however, eased in the second half of last week, mainly supported by an unreservedly bullish US oil inventory report. Especially the demand side of the oil equation was viewed as encouraging and showed that the road to economic re-opening leads through inoculation programmes.

It is the unvaccinated part of the population in the Western world that causes fresh headache for policy makers and investors alike. The highly infectious Delta variant of the virus is spreading rapidly in Australia and South Korea whilst Tokyo entered a fresh state of emergency less than two weeks before the start of the Olympic Games. Even the finance ministers of the G20 countries warned of negative economic impact of the of the virus and emphasized that the downside risk is a very clear and present danger due to the “two-track recovery” caused by the uneven availability of vaccines.

The current blurred picture capped any attempts to push prices higher. WTI finished the day 46 cents/bbl lower and Brent lost 39 cents/bbl on the day. Another notable feature of yesterday’s performance was the conspicuous weakness in the structure of the two crude oil futures contracts. The August/September WTI spread fell 9 cents/bbl and September Brent weakened 7 cents/bbl against October. This, however, probably has more to do with monthly rolls of length than with genuine fears of protracted and meaningful demand destruction.

Solid fundamental backdrop

The carefully orchestrated plan to manage the global oil balance was upended last week and the spanner was thrown in the works by the United Arab Emirates and its close ally, Saudi Arabia. The two, perhaps most influential, members of OPEC are at odds about how to deal with the 2022 oil balance and what base line to use when calculating individual production quotas. The same way as financial investors were borrowing demand at the end of last year in anticipation of demand recovery, they have heavily borrowed futures supply after the OPEC+ stand-off, worrying about a potential supply glut in case the UAE decides to go alone and open the tap. Nerves have been somewhat calmed after two days of panicky selling, but the water is still as muddy as a week ago. There are quite a few question marks lingering above the market. At this stage it is impossible to know whether the Emirates wish of higher baseline will be granted, if yes, whether others will want to join the UAE in claiming higher production quotas. The UAE leaving OPEC, temporarily or permanently, is also a (probably distinct) possibility. As noted last Tuesday’s report there is about 6 mbpd of production is at stake. This is difference between the current output restraints and the combined base line figure.

The future is, indeed, unpredictable and under this challenging scenario it is useful to take stocks what the current supply-demand backdrop offer. Last week’s monthly EIA report envisaged a relatively upbeat 2H 2021. It will be interesting to see whether the IEA and OPEC agree with it when they release their take on the oil balance later today and on Thursday. Until then the weekly EIA Petroleum Status Report can provide a clue on how balanced the US market is, which then can be used as a reliable proxy for OECD and global oil balance. As 2020 was the most unprecedented year in the oil market it is only reasonable to measure current inventories, demand figures and prices with the comparable period of 2019. And the picture is upbeat.

The bottom line is that the pre-pandemic levels have been reached and breached in most cases. To begin with prices, WTI is 30% and Brent is 18% higher than two years ago whilst the structures are also firmer. The M1/M6 WTI spread, which is well over $4/bbl was at parity in July 2019. The same differential in Brent around $3.60/bbl is more than $2/bbl stronger than two years ago.

Inventories are below the 2019 level. Commercial stocks have been depleting for more than a year now and last week they were 35 million bbls or 2.7% lower than at the beginning of July in 2019. This drawdown is largely due to crude oil inventories that lost 3% in the last two years. This also means that products have room for improvement as they are still higher than the pre-pandemic – gasoline by 3% and distillate stocks by 6%.

These surpluses are likely to be worked off if recent demand trends are anything to go by. Both gasoline and distillate consumption figures are higher than in the corresponding period in 2019. Gasoline demand surged over 10 mbpd last week for the first time since records started. US jet fuel consumption is understandably sluggish. It is still 24% lower than two years ago but as the US opens up and air travel resumes it is also expected to increase further improving refinery margins and thirst for crude oil.

As said above the abandoned OPEC meeting can ultimately lead to a price war. However unlikely this scenario is it must not be discounted just yet. Nevertheless, widespread vaccination programmes, relatively low oil inventories and improving demand outlook should mitigate the impact of a supply glut – if it materializes. If not, then $70/bbl basis Brent looks a reasonable bottom in case of further short-term retracement and turbulence.