After “Black April”, the month that saw an unprecedented plunge in oil demand and the first-ever drop of WTI crude futures into negative territory, the darkness is lifting for the oil markets. That was the message from the IEA as it released its latest monthly report yesterday. The updated forecasts pointed to a tentatively improving outlook for the oil balance amid a rebound in demand and a plunge in global supply.
Optimism on the demand side of the oil equation came courtesy of the quicker-than-expected easing of containment measures and resumption of economic activity. This will result in a narrower fall in demand during the first half of the year than previously thought. While the decline in oil demand during 1H20 may not be as steep as first feared, the demand outlook for 2H20 is slightly weaker than previously forecast. Demand will fall by 4.6 mbpd compared to 2H19 which is steeper than the 4.3 mbpd drop predicted last month. Nevertheless, the IEA still upwardly adjusted its global oil demand forecast for the year. The agency now expects world oil consumption will average 91.23 mbpd in 2020, down 8.6 mbpd from last year but 690,000 bpd more than last month’s estimate. That said, the forecasted annual decline for 2020 still represents the largest drop on record. What is more, it warned that it may take several years for global oil demand to return to pre-COVID levels. In short, a return to the 100 mbpd threshold is a long way off.
On the supply front, the accelerating production shut-ins outside of OPEC have greatly contributed to the supportive backdrop. Faced with tepid demand and low oil prices, non-OPEC crude supply has been falling faster than expected. By April, non-OPEC output was estimated to have declined by more than 3 mbpd since the start of the year. And there are no prizes for guessing the epicentre of this collapse. Fresh drilling and completion activity has practically ground to a halt across the US shale patch. Accordingly, the IEA estimates that US crude output could fall 2.8 mbpd by the end of the year and drop more than 1.1 mbpd for the year on average compared to 2019. Total non-OPEC supply is now forecast to decline by a record 3.2 mbpd in 2020, an increase of 900,000 bpd compared to last month’s estimate. It should, however, be noted that the bulk of this pullback will take place in the current quarter. Supply from producers outside of OPEC should remain steady throughout 2H20.
At the same time, the other supply development acting as a boon for the oil rebalancing are OPEC-led cuts. OPEC+ has throttled back production this month as the supply cut pact came into effect. At the forefront of these efforts to curb output are the group’s core Arab producers. Saudi Arabia, Kuwait and the UAE recently revealed that they will enact deeper-than-agreed production cuts next month. Furthermore, they favour extending these cuts though the end of the year. The upshot of this is that OPEC production could feasibly average below 25 mbpd for the rest of the year. Demand for the oil cartel’s crude is seen at 30 mbpd in 2H20 by the IEA. The stage is therefore set for depletion of oil stocks to the tune of more than 5 mbpd in the second half of the year. This, in turn, should help drawdown a good chunk but not all of the implied 9.7 mbpd surplus pencilled in the for 1H20.
In sum, oil demand is on the path to a gradual-but-fragile recovery and world’s major oil producers closing the oil spigots. This should provide a reprieve for the oil balance in 2H20 after a brutal showing in the first half of the year. Yet this encouraging statement comes with an important caveat: there is still a significant degree of uncertainty for the oil balance. This is due to the threat of two potential risk events. The first is a resurgence in COVID-19 outbreaks as shuttered economies reopen. The second is deteriorating compliance to OPEC+ cuts in the year-end period. These two evolving price catalysts risk putting paid to any hopes for a sustained recovery. Oil may have moved out of the darkness and into the light but the shadows are still lurking.
On the front foot
Those of a bullish disposition took heart from the IEA’s soothing forecasts. Indeed, the prospect of a looming supply deficit mollified fears that storage tanks will reach their tops. Brent duly rallied $1.94/bbl to settle at $31.13/bbl while WTI tacked on $2.27/bbl to finish at $27.56/bbl. Buying pressures were also spurred by figures showing Iran’s oil shipments sunk to a record low of 70,000 bpd in April. All the while, Saudi Arabia continued to lead from the front in limiting supply. Aramco announced it has cut June crude allocations to at least three buyers in Asia by between 10-30%. Supply and demand dynamics are clearly improving but such is the scale of the global oil stock overhang that it will persist for a long time to come. In view of this, further price gains are by no means assured with the only certainty being more volatility.
The same is true for stock markets. A choppy session saw shares on Wall Street see-saw between gains and losses yesterday. Investors initially dwelled on Wednesday’s downbeat comments by the chair of the Fed not to expect a quick recovery from the coronavirus pandemic. Adding to this bleak prognosis were warnings from the WHO that the world may never be rid of COVID-19. Yet they played second fiddle to hopes that easing lockdown measures will help revive the US economy. Not even a fresh helping of grim US jobs data could spoil a positive close for leading US stock indices. Another 2.9 million Americans applied for unemployment benefit last week, taking the total number of claimants since the start of the crisis to more than 36 million.