Equities and oil are, for the most time, two peas in a pod. That is, they usually move in tandem. This relationship has been on full display in recent weeks but yesterday provided a rare exception to the rule. The former closed higher amid improving economic data. A batch of better-than-expected business surveys showed the economic downturn in the eurozone and US slowed markedly this month. There was even a surprise expansion in UK manufacturing activity after a three-month slump. Meanwhile, the WTO said global trade would likely fall less than its worst case scenario this year. All this added to mounting optimism that the global economy has turned a corner.

Oil initially moved higher on Tuesday to trade at fresh three-month highs. Yet these gains fizzled out later in the day as a bout of profit taking pushed the two leading crude markers into the red. Brent finished the session 45 ct/bbl lower at $42.63/bbl and its prompt timespread slumped back into contango. WTI lost 36 cts/bbl to close at $40.37/bbl. Bulls were dealt a further blow after the close following a double whammy of renewed virus jitters and oversupply concerns. Market players were spooked by a resurgence in COVID cases which saw the US report its biggest one day jump in two months. All the while, staying in the US, the glut alarm bells were sounded by the API after it reported another build in crude stockpiles. Stocks rose by 1.7 million bbls last week which was ahead of expectations for an increase of 299,000 bbls. It was a different story on the product front. Gasoline and distillate fuels inventories fell by more-than-expected at 3.9 million and 2.6 million bbls, respectively. Nevertheless, the spotlight is firmly on the mammoth US crude stock overhang.

Laggard watch

 The US crude benchmark has joined Brent above the $40/bbl threshold this week. This caps a remarkable turnaround from April’s historic venture into negative territory. Prices have been buoyed by early signs of a recovery from the COVID economic shutdown, the pullback in US crude production and the onset of OPEC+ cuts. The road back above this milestone has prompted a slew of bullish forecasts for the near-term. Yet while oil prices have stabilised in the $40s, plenty of downside risks remain.

First and foremost is the threat of a second coronavirus wave. The pandemic is still far from contained and is in fact worsening. Cases are on the rise globally. Last weekend the WHO reported the biggest single day increase to date at more than 183,000. Latin America has emerged as the new epicentre although fresh clusters have been reported in the US, China and India. These are all important oil demand centres. A second wave of infections and lockdowns will derail the global economic recovery and with it, oil demand and prices.

What is more, as data points to a fledgling rebound in economic activity, the reality is that the global economy has by no means shaken off its COVID-induced malaise. A case in point is the US. Joblessness remains stubbornly high. Continued unemployment claims have topped the 20 million mark for the last seven consecutive weeks. Moreover, retail sales posted a record rebound in May but are still only on par with levels seen in late 2015. All the while, the US housing sector is in the doldrums. Sales dropped to a near-decade low. Housing starts recovered last month but are still near a five-year low. In short, the US economy is a far cry from the pre-pandemic level. Even so, shares on Wall Street are back to where they were before the coronavirus struck. This bares all the hallmarks of a stimulus-driven speculative bubble, which, if burst, could spell ruin for oil bulls.

On the supply front, the major fly in the ointment is sub-compliance to OPEC-led supply curbs. Iraq has earned notoriety as a compliance laggard in past OPEC+ production deals and this time is no different. OPEC’s second-biggest producer had agreed to reduce its production by more than 1 mbpd. Yet last month’s output stood at 4.16 mbpd, according to OPEC-surveyed secondary sources, some 560,000 bpd above its output target of 3.6 mpbd.

More recently, however, Iraq has been sending positive signs. It agreed last week to institute extra cuts below its quota in the coming months to compensate for overproduced volumes in May and June. Iraq’s oil output should now fall as low as 3.3 mbpd in July. This comes after Baghdad agreed with major oil companies operating three of its largest oilfields to further reduce production. The OPEC nation also appears to be trimming exports volumes in an effort to boost its compliance to OPEC+ cuts. Shipments are poised to average 2.8 mbpd this month, according to the country’s newly appointed oil minister and down from 3.2 mbpd in May.

Despite these efforts to meet its production quota, Iraq still faces widespread scepticism. After all, it has shown itself to be untrustworthy in the past. Furthermore, the country is riddled with political instability and security risks. Nevertheless, it is paramount that Iraq and the group’s other underperforming participants achieve full compliance to agreed cuts. Otherwise the OPEC+ agreement will most likely unravel. The message is therefore clear: OPEC laggards must transition from delinquents to disciples if the oil market’s nascent recovery is to be sustained.