Nowadays the only things that are certain in life are death, taxes, and volatility in the oil market – price volatility, extreme weather conditions, unexpected and significant revisions in supply or demand estimates, geopolitical developments, all leading to erratic investor sentiment.
The massive price fall we saw in August reversed a little more than a week ago, but the recent optimism is fading, and gains have been capped. The halt in the price rally is possibly due to the uncertainties surrounding the global oil balance going forward and not even a generally constructive weekly EIA statistics on US oil stocks was able to provide sustained price supports yesterday. The more than 7 million bbls drawdown in crude oil inventories (9 million bbls in PADD3) was casually swept aside as market players concentrated on the unexpected 1.3 million bbls build in gasoline inventories. On a side note, the crude oil draw came despite net imports were broadly unchanged and domestic production edged up to 11.5 mbpd implying that the impact of Ida will be felt in next week’s data. The hurricane-induced refinery closure will also be reflected in next week’s stats as runs were up 1% in PADD3.
The 1.7 million bbls decline in distillate stocks took inventories in this product some 23% below last year’s level – hardly a green light for a sell-off. The most encouraging part of the report, however, was found on the demand side once again. Products supplied, a proxy for domestic consumption, has probably exceeded expectations. The weekly reading stood at 22.82 mbpd, the highest figure on record. Gasoline demand is solidly around 9.5 mbpd, distillate consumption rose by 300,000 bpd to 4.39 mbpd and the most welcome development was the 400,000 bpd jump in jet fuel demand to 1.8 mbpd, the highest since the outbreak of the pandemic. If oil consumption is anything to go by, then the US is firmly powering ahead.
This upbeat mood is confirmed by the performance of the stock market. MSCI’s all-country world index reached for a new all-time high despite tepid growth in Asian manufacturing activity in August. The good news, however, was that despite persistent supply chain bottlenecks factories in the US managed expand their activities, a sign of robust demand for their products. Although oil is lagging equities, its downside is clearly limited by the general confidence surrounding the global economy despite consistent fears of the prolonged spread of the coronavirus.
Further challenges lie ahead for OPEC+
Even by recent standards there is a turbulent month behind us. The major oil contracts all lost value. WTI was leading the way down with a loss of 7.37%. Brent fell 4.38% whilst products fared better. Heating Oil produced a negative return of 3.11% and RBOB shed 3.52% of its value. One might conclude that the performance in August was anything but encouraging. Others would take heart from the bounce off the lowest prints of the months. They would also be eager to point out that it was only the second month in 2021 when the market lost value and the year-to-end-of-August returns at around 40% are more than respectable.
Prices were and are being influenced by a number of factors last month. The most important of these are the economic impact of the Delta variant of the coronavirus that raised concerns in the first half of the month about demand growth. Noises out of the Federal Reserve on tightening the ultra-lose monetary policy had a profound impact on the dollar, which, in turn, shaped the sentiment in the oil market. Geopolitics, the US troops withdrawal from Afghanistan was also a force to reckon with.
These developments shaped not only the sentiment but ultimately the oil balance, too. The good news is that the Delta variant of the virus did not dent consumers’ optimism. The global manufacturing sector did suffer, partly because rising infections had a tangible impact on factories and on supply chains. However, according to unofficial data that comes in the form of high frequency indicators like recruitment, travel and spending, the economic recovery is well under way, especially in the developed part of the northern hemisphere.
The supply side of the oil equation also looks positive and when the two are set against one another the net result is continuous depletion in global oi inventories for the rest of the year. OPEC and its 10 allies decided to go ahead with the planned tapering yesterday (this is a fashionable word these days) and to raise production by 400,000 bpd in September. Assuming that the schedule will go ahead at least for the rest of the year OPEC’s 3Q production is expected to be 27.1 mbpd and some 1.1 mbpd higher in 4Q. In case of resilient oil demand global oil inventories are to decline around 1 mbpd. This is a very uplifting prediction.
The situation could start deteriorating in 2022. According to the Joint Technical Committee of the producer group next year would see the return of surplus in the region of 1.6 mbpd (revised down from 2.5 mbpd from the day before because of a meaningful upside correction in global oil demand) in case the alliance keeps increasing production by 400,000 bpd per month until the output constraint implemented in April 2020 is completely lifted. This could completely wipe out this year’s stock draw. In case output is upped by a combined 2 mbpd between August and December the group will have a little less than 3 mbpd to go until the pre-pandemic status quo is restored. To balance the global market in 2022 the group might have to deviate from the current plan based on its own calculation. In other words, OPEC+ could easily find itself in a situation again whereas they will need to show restraints in order to prevent oil prices from falling. From July to August the demand for OPEC oil was reduced from 28.68 mbpd to 27.61 mbpd for next year. A seemingly manageable oil balance has suddenly deteriorated by more than 1 mbpd. The last year or so required unprecedented discipline from the group in its attempt to balance the oil market. The planned 400,000 bpd output increase into 2022 might have to be treated the same way as the inflation targets of central banks – in a flexible manner, otherwise tangible signs of global stock builds will lead to a loss of market confidence. There will be a lot to ponder in coming months and amongst these uncertainties what will remain certain are death, taxes and volatility.