Fear of the repeat of last month’s WTI expiry is proving to be unjustified. Quite the opposite is taking place. The US benchmark rallied $2.39/bbl yesterday, settled at $31.82/bbl and the front spread closed in backwardation. The expiring June contract is gaining further ground against July on very light volume and is printing +60 cents/bbl. Open interest was 34 million bbls last night compared to 109 million bbls a month ago. The strong expiry comes despite Cushing stocks are 79% full and are 10% higher than the 5-year average. The WTI strength, therefore, has nothing to do with stock levels but is down to two factors: speculative shorts squaring their books and the profound and recent change in broader market sentiment.
The respectable oil market performance was also aided by galloping equities. All Wall Street needed was positive results from a COVID-19 vaccine trial by Boston-based biotech company Moderna. Investors were further encouraged by the easing of lockdowns in crucial economies. The DJIA gained 3.85% on the day and the S&P 500 was not lagging behind by much as it settled 3.15% higher. Risk is back on and the Fed chair’s warning from last week about painful economic recovery has been confined to the history books.
Backwardation likely to make a cameo appearance
A powerful cocktail made of bullish ingredients have been supporting the oil market for a month. These ingredients have been fashioned by the health crisis. The coronavirus outbreak that devastated both oil producers and consumers is now helping prices to recover. The health crisis induced sell-off has created significant reductions, forced and voluntary, in global oil production. As lockdown measures are being relaxed the demand side of the equation is receiving a boost, as well.
Physical demand is picking up. As mentioned in yesterday’s note thirst for gasoline in the US is growing. It has jumped from 5.06 mbpd at the beginning of April to 7.40 mbpd last week, according to the EIA weekly report. The CME June RBOB contract rallied 556 points yesterday and has more than doubled since the March low. On the other side of the globe China is trying its best to go back to normal and its efforts are reflected in the April crude oil import data. Around 9.84 mbpd of foreign crude arrived last month, up from 9.68 mbpd the previous month. Its present oil demand is said to be very close to the pre-pandemic level. In India requirements for products are also growing. Admittedly, additional demand has been created by SPR buying as countries have rushed to take advantage of distressed oil prices. The latest assessment from the IEA puts the global available spare storage capacity at 240 million bbls at the end of April. Given that the massive production cut from the OPEC+ group came into effect at the beginning of this month the fears of tank tops have greatly subdued. Global oil demand is set to average more than 15 mbpd above the horrendous 2Q consensus figure, providing further encouragement for oil bulls.
Global production is equally price supportive. Non-OPEC supply is forecast to stand at 61.05 mbpd in 2Q-4Q, down from 66.71 mbpd in 1Q. US oil output has already started to decline and has fallen to 11.6 mbpd, the latest EIA statistics shows, down from 13.1 mbpd in February. Rig counts are at 258, the lowest ever as shale companies are filing for Chapter 11 bankruptcy. June shale oil output is projected to be 7.82 mbpd, 1.2 mbpd lower than in March. Combined US and Canadian output will have fallen by around 3 mbpd by next month, it is estimated.
And then there is the OPEC+ group. The latest agreement to cut production by 9.7 mbpd for May and June was certainly well received and Persian Gulf producers boldly upped the ante by announcing an additional curtailment of 1.2 mbpd. Better yet, the initial signs points to strict compliance. Russian oil production has fallen to 9.43 mbpd in May 1-14 from 11.35 mbpd in April. According to Petro-Logistics, OPEC exports during the May 1-13 period stood some 5.96 mbpd below last month’s average. Several OPEC members have cut their OSP for June. Saudi Arabia, for example, is selling its Arab Light to Europe at a discount of $3.70/bbl to BWAVE, up from -10.25/bbl in May. There are even talks that the extent of the restraint pencilled in for May and June would remain in force for the rest of the year.
Demand is improving, supply is decreasing and consequently prices are climbing higher. Not only flat price, which has doubled over the last month in Brent, but assorted spreads, too. The contango between the first- and fourth-week Brent CFD that was more than $2/bbl at the beginning of the month is now only 30 cents/bbl. The discount of dated Brent to forward has narrowed from $7/bbl three weeks ago to $1.50/bbl. The June Dubai swap is now assessed very close July (it displayed a discount of $2/bbl three weeks ago) and front month WTI could expire above the second month. The two main crude oil front futures contracts could easily flip to and spend the next month or two in backwardation.
This improvement in sentiment, however, is expected to be relatively short-lived. As oil prices keep climbing production restraints will ease. Non-OPEC producers are likely to raise their output and the temptation for members of the non-OPEC+ group will also grow to deviate from their quotas. The current tight oil balance predicted for the second half of the year will probably loosen. This will be helped by demand considerations. Economic output will grow compared to the current quarter but will be well below the levels expected at the beginning of the year. The biggest concerns are probably unemployment and Donald Trump. As nearly 4 billion people have been locked down globally the number of those who have lost their jobs have risen sharply in the last two months. A big portion of them will not be re-employed. In the US 37 million people filed for unemployment benefit in the last six weeks. In the Eurozone the rate of redundancy climbed only marginally to 7.4% in March, but consultancy McKinsey expects unemployment doubling in the European Union this year. This will act as a break on oil demand growth. The US President’s primary goal is to reboot the country’s economy in the run up of the November elections. He will do it without consideration of the consequences. He has one letter in mind: V. This is the shape of the economic recovery he is hoping for, which will ultimately lead to Victory in November. If this ruthless and reckless approach backfires and a second wave of the virus hits the US stock markets will dive again.
The current recovery is most pronounced in the US. Gasoline demand is rising, Cushing stocks drew last week, the front-end of the WTI curve is in backwardation now and crack spreads, especially RBOB cracks are strengthening. We believe that whenever the current sentiment turns, it will be first felt in the US. It will come in the form of rising or at least stabilizing US crude oil production, a halt in the increase of demand and continuous fall in product exports resulting in domestic inventory builds. Net US product exports have already halved in the last four weeks and was just 2.1 mbpd last week. As Energy Intelligence pointed it out there is a fleet of tankers loaded with US gasoline waiting off the shores of Mexico, Ecuador and elsewhere as demand has virtually dried up. In Asia, the rise in Chinese crude oil imports and processing means higher refinery runs. This will lead to an increase of product exports in the region that is already well-supplied. The situation is not expected to improve in the near future.
The recovery that we are experiencing is somewhat inevitable although it has come earlier than we originally anticipated. Its speed also took most by surprise. Currently the top is not in sight. The market will ebb and flow in the immediate future with the underlying trend being up .The same way as the recent price crash was exaggerated (especially in WTI a month ago), the correction might also overshoot to the upside. Two weeks ago it would have been inconcievable to talk about filling the gap the crude contracts left on the daily charts after Russia refused to endorse the Saudi proposal of a cut of 1.5 mbpd at the beginning of March. These are now semi-realistic targets and are $41.05/bbl on WTI and $45.18 on Brent. It hardly ever pays off to swim against the current. You might not drown but you will be left badly bruised as you fight to stay afloat. What is advisable is to go with the flow but look out for signs of weakness -supply, demand, and stock market- and be brave to change direction fast when bearish signs are starting to re-emerge.