Even those who could not follow the news and markets last week would be aware just by looking at the daily price changes that the oil market was influenced by two opposing forces. The price movement was comparable to playing a game of pin ball as sharp selloffs were followed by equally intense rallies. Last week finished on a slightly positive note but whether the uptrend will resume instantly is anything but dead cert.

The downside pressure came from a reliable source. There is a tangible unease about immediate demand growth due to the problematic roll-out of vaccinations. This negative sentiment ebbed and flowed as last week’s incident in the Suez Canal raised the fears of oil short-term disruption in oil supply. These fears have been removed this morning as the 200,000 tonnes tanker, Ever Given has reportedly been refloated. Now that the Suez mini crisis is being resolved the oil market is left to its own fundamental devices again and attention will shift back to the stuttering inoculation programmes, the seemingly unstoppable rise in infection rates in several parts of the world and the upcoming OPEC meeting on April 1.

The latest Commitment of Traders reports from both the CFTC and ICE cover the period March 17-23. During these five trading sessions the oil market underwent two massive sell-offs – on Thursday, March 18 and on the following Tuesday, March 23. The current set of data, therefore, is indicative of the thinking of money managers of these price drops. The conclusion one can draw is that they have turned careful but not bearish yet. Financial investors of both main crude oil futures contracts have shed a considerable amount of length as prices dived more than $7/bbl from the previous reporting period. This outflow of money ($10 billion week-on-week), however was the function of closing out existing long positions, rather than betting on protracted weakness. The 21 million bbls fall in WTI’s net speculative length consisted of a cut of 17 million bbls in long positions and an increase 4 million bbls in short positions. In Brent gross length has been reduced by 37 million bbls and bears added 15 million bbls to their exposure. Growing demand concern triggered some fierce long liquidation, but the speculative sentiment has not turned unreservedly negative for now.

Precursor of demand recovery is product inventories

The latest rally that doubled the price of Brent between November and March came to an abrupt, and maybe a not so unexpected, end due to demand considerations. It is well publicized and frequently mentioned, also on the pages of this report, that vaccinating the majority of the population in most countries has turned out to be much slower and more problematic than anticipated a month ago. Consequently, demand estimates have constantly been revised down. This is likely to be the case in April, especially for the second quarter of the year and particularly in OECD Europe. Growing concerns about the health of the economy and oil demand together with the strong dollar made a lethal bearish cocktail that has proved as effective as any of the available inoculations. It temporary knocked out oil bulls as the price of the European benchmark dived more than $10/bbl in the space of two weeks at the beginning of this month.

An unmistaken sign of growing consumption will be the depletion of oil inventories. Stock levels are always a widely watched barometer of the oil balance and they have a profound impact on oil prices. The lower stocks, the higher prices. Monthly IEA data on crude oil and assorted product stocks in the developed part of the world reveals an encouraging picture but at the same time implies that further hard work is required to convince the market about the irreversible expansion in oil demand.

What catches the eye is that OECD crude oil inventories have fallen since last October, but product stocks have failed to follow suit. Crude oil stocks fell some 4% between October and January whilst gasoline inventories built by nearly 9% during the same period and distillate stockpiles remained largely unchanged. The divergence between the two main product categories is the function of seasonality – demand for products in the middle of the barrel rises during the winter months. In OECD Americas crude oil stocks fell by 17 million bbls in those three months (-2.5%) whilst gasoline and distillate inventories grew by 11% and 7% respectively.

The drawdown in crude oil inventories was the function of refiners scaling back their spot buying due to the backwardated nature of the crude market (Brent contango started to narrow in October and it flipped into backwardation in November) and ramping up their utilization rates. US refinery runs, for example, rose from 73% in the middle of October to 83% by the end of January. Arduous demand growth, that was continuously cut since last October led to the build-up in product inventories.

Crude oil stocks and demand, in themselves, are not reliable indicators of the health of the global oil balance. They are only half of the story. Demand for crude oil exclusively comes from refiners and if it is not matched by at least an equal growth in thirst for products the oil market will remain oversupplied. The oil balance will tighten when product inventories start depleting. And the signs on that front are promising.

The cold winter in the Northern hemisphere, including the Texas freeze helped to drain product inventories in the US and elsewhere. Energy Intelligence estimates that adverse weather conditions led to a 70 million bbls fall in global product stocks that have now fallen to levels not seen since the break-out of the pandemic. It also projects further tightness as Asian refiners will undergo heavy maintenance next month. Should the end of this maintenance coincide with a ramp-up in inoculations in Europe, India and elsewhere, the current rather ominous demand picture could quickly take a turn for the better.

The question is not whether global product consumption will pick up but when. Rallies based on perceptions can backfire as oil bulls learnt it the hard way this month.  The market will probably react to palpable draws in product inventories. From this respect a helping hand is available in the form of the highest frequency of data on product stocks, the weekly EIA report on US inventories. As stocks on the other side of the Atlantic make up more than 40% of OECD inventories continuous drawdowns in the US could easily form the base, on which the next leg higher will be built.