After three days of losses and a near six-dollar price rout, Brent and WTI finally managed to regain some poise yesterday. The two leading crude markers tacked on around $1/bbl on Thursday as battered oil bulls emerged from the woodwork. Price support came courtesy of simmering Middle Eastern tensions. Israel launched air strikes in south Lebanon in response to rocket attacks. At the same time, the country’s defence minister hinted that it was prepared to strike Iran. This came as the Persian Gulf nation swore in new President Ebrahim Raisi.
All the while, adding to the more supportive mood, virus-related demand jitters took a breather. Fears over rising cases of the Delta variant have been top of the mind, especially in China which is experiencing its worst Covid-19 outbreak since the early days of the pandemic. Mercifully, China posted its first decline local new cases this week, as a health official said he expected China’s latest outbreak to be largely under control within weeks.
Going forward, oil prices are expected to extend their recovery, albeit at a modest pace, as near-term fundamentals get tighter. Echoing this sentiment is UBS. The bank injected some bullish impetus after claiming that oil should resume its upward trend amid the ongoing decline in global oil inventories. It expects Brent crude to trade between $75 and $80 over the remainder of the year. This seems like a safe bet with oil demand recovering despite the Delta spread and continued optimism in OPEC’s supply management.
The Great Drawdown
Cast your mind back to spring 2020. “No Vacancy” signs were dotted all over storage hubs in Cushing. Now those same storage tanks are draining at a blistering pace. Stockpiles at the delivery point for the US crude benchmark have just notched their eighth straight weekly draw. Most recently, crude stocks at Cushing fell by 543,000 bbls in the week to July 30, to stand at 34.9 million bbls. This is a decline of 33% compared to this time last year and the lowest level since January 2020.
Spearheading this rapid drawdown is a trifecta of factors. For starters is the backwardation of the WTI Cushing complex. This has helped drive the inventory drawdown. Secondly, domestic fuel demand has recovered strongly over the summer months. Latest EIA data puts US product supplied, a proxy for fuel demand, above a pre-pandemic norm of 21 mbpd. Thirdly, US crude oil production has remained relatively flat at around 11 mbpd in recent months. American producers have held fast to vows made over the past year to focus on balance sheet repair and shareholder returns strategy in lieu of growth.
The question now is whether the current pace of Cushing inventory draws can be sustained. Well, on the account that demand continues to outstrip supply for the rest of the year as US producers maintain their conservative stance, the answer is yes. Small wonder, then, why several market observers are anticipating more draws. Among them is Rystad Energy. They see Cushing stockpiles falling into the 20-million range by the end of summer which would be the lowest since 2011. All the while, the drawdown of Cushing stocks will likely be exacerbated by the recent reversal of the Centurion pipeline, which instead of transporting crude to Cushing is now taking oil away from it. Simply put, all the signs suggest that there is still some room to the downside for Cushing inventories.
Assuming the downward trend in Cushing stocks continues from here through the rest of the year, this ought to pave the way for firmer WTI prices. This, in turn, will also contribute to the narrowing in the WTI/Brent spread. The US oil benchmark’s discount to Brent has narrowed significantly since early June, at one point falling below $2/bbl. The upshot of this is that US crude exports bound for Asia have become less competitive relative to their Brent-based counterparts. And sure enough, US crude shipments fell to a 12-week low in the week ended July 30. This brought the latest four-week average to under 3 mbpd for the first time since late May.
The WTI/Brent spread has since widened to around -$2.20/bbl. Yet this is unlikely to offer US crude exporters enough breathing room to ramp up flows along the US-Asia trade route. What’s more, in its latest monthly report, the EIA forecast that WTI’s discount to Brent will stay under $3/bbl over the remainder of the year. US crude exports will therefore continue to see pressure from weakening of arbitrage incentives. When it comes to the near-term outlook for the US crude export machine and Cushing stocks, it looks set to be a case of lower for longer.