Buying pressures sprung back to life yesterday amid increasing OPEC+ enthusiasm for cuts. Saudi Arabia, Kuwait and the UAE have all pledged to enact deeper-than-expected output cuts next month. What is more, the Saudis called on other OPEC+ members to follow suit as they take the fight to the global oil glut. Such is the affinity for production restraint that rumours are now circling that the producer group will not reduce the size of cuts beyond June.
As the OPEC+ alliance doubles down on supply curbs, the supply growth outlook for US crude continues to go from bad to worse. In releasing its updated oil estimates, the EIA forecast that US crude output will shrink at a faster rate this year than previously thought. Production will drop by 540,000 bpd in 2020 to 11.69 mbpd which is 70,000 bpd more than last month’s forecast. Furthermore, the rate of decline is poised to accelerate next year. US crude output is predicted to fall by 790,000 bpd in 2021. Should this turn out to be accurate, it would mark the first time US crude output declines for two years in a row since 2008.
The deteriorating outlook for the US shale patch coupled with deepening OPEC+ cuts made for a supportive price backdrop on Tuesday. WTI rallied $1.64/bbl to finish at $25.78/bbl while Brent gained 39 cts/bbl to finish at $29.98/bbl. Yet amid these bullish supply-side developments are pockets of demand concerns. Fears are running rife that easing lockdown measures will trigger a second wave of coronavirus infections. This comes as Germany, China and South Korea reported fresh outbreak after relaxing virus restrictions. Suffice to say, the tug-of-war between OPEC-led cuts and virus anxieties will limit upside price potential.
In the meantime, all eyes are on US oil inventories. The API set a bearish tone after reporting that US crude stocks rose by 7.6 million bbls last week compared to expectations for a build of 4.1 million bbls. That said, it did include a drop of 2.3 million bbls at the Cushing hub. Should this be confirmed by official data later today, it would mark the first drawdown since February. All the while, gasoline inventories fell by a smaller-than-expected 1.9 million bbls and distillate fuels stockpiles jumped by a forecast-beating 4.7 million bbls.
The refiner’s least favourite child
The COVID-19 pandemic has sent crippling ripples through many industries, but few have suffered more than the aviation sector. Travel restrictions resulted in a 90% decline in global air traffic last month. Airlines remain grounded and are set to lose out on more than $300 billion in revenue this year, according to the International Air Transport Association. The air travel industry is clearly in the doldrums which has, in turn, slammed jet fuel demand. Global consumption for the fuel is expected to fall by 2.1 mbpd or 26% this year, according to the IEA. Others are even more pessimistic. Rystad Energy sees global jet fuel demand falling by almost 34% on an annualised basis over the course of 2020.
Mercifully, the gradual lifting of lockdown measures has triggered a pick-up for transportation fuels. A case in point is the US. Consumption of gasoline and distillate fuels, which includes diesel, is recovering rapidly from the early-April nadir. Demand has increased in the last three consecutive weeks, reaching 6.66 mbpd and 3.13 mbpd respectively in the week to May 1. There is, however, one notable absentee from this rebound. Jet fuel demand in the US is still depressed. Consumption is wallowing at 515,000 bpd, less than a third of the level one year ago. Moreover, it is barely a smidge above a record low of 463,000 bpd hit during the week to April 10.
Clearly, jet fuel is lagging behind its peers. It is the hardest hit among the various fuel sectors and this fall from grace is reflected in dire refining margins. The physical crack fell into negative territory in Asia and Europe last month. Asian cracks for jet fuel fell to fresh lows last week, dropping to more than $7/bbl below Dubai crude. Small wonder, then, that refiners have been scaling back jet fuel output. In the US, jet fuel supply has plunged, so much so that Atlantic coast jet fuel production fell to negative levels for the first time in 20 years in the final week of April. Refiners have also reprocessed jet fuel into higher margin products such as naphtha. Meanwhile, those still struggling with excess jet fuel stocks have resorted to giving it away. BP donated 3 million gallons of jet fuel to help in the delivery of personal protective equipment and other essential goods in the U.S.
Looking ahead, global jet fuel demand is expected to remain depressed and by some estimates could take several years to recover from the coronavirus crisis. Wood Mackenzie is currently forecasting a “multi-year recovery” in global jet fuel. Others are less sanguine. Goldman Sachs, for instance, signalled this week that there is no guarantee that the aviation sector would return to pre-pandemic levels. They point to changing customer’s habits that may outlast the pandemic. The obvious example is the newfound pervasiveness of videoconferencing which risks permanently denting business travel. All the while, leisure travel in the coming months will be undermined by a global recession and loss of consumer confidence. In short, the air travel industry and therefore jet fuel demand is bracing for a new post-virus norm.
This lower for longer outlook should provide a strong message for the global refinery system. Specifically, that it should keep jet fuel supply at minimum rates in the near-term and tilt yield towards gasoline and diesel. The structural change for airline demand also has important implications for the investing community. The fact is that there will be no quick return to the pre-virus days for airline shares. In what may be a sign of things to come, Warren Buffett revealed that his Berkshire Hathaway conglomerate sold its stakes in the “big four” US airlines. These are gloomy times for the airline industry and jet fuel demand. Yet there is a silver-lining for travellers. Airlines are widely expected to slash prices once the pandemic ends as they race to win back passengers. Bring on summer 2021.