After a wild 2020, the new year has begun with bullish cheer and optimism filling the air. Friday’s sea of green capped a stellar week for the energy complex. Brent and WTI rallied more than $1/bbl to settle at their highest level in nearly a year. Never mind than most of Europe is now under strictest restrictions. Or that the new strain of the virus is putting more downside risks on the oil markets in the first half of 2021. The fact is that the Saudi decision to unilaterally cut output is a reflection of weakening underlying demand fundamentals. Yet market players were more than happy to overlook this inconvenient truth.
Not wanting to be left behind, shares on Wall Street also continued their record rally. The S&P500 and Dow Jones scaled fresh highs at the end of 2021’s first trading week. Investors shrugged off rising Covid infections and the latest instalment of gloomy US economic data. Friday’s non-farm payroll report revealed that the labour market recovery swung into reverse after firms shed 140,000 jobs last month. However, in a classic case of “bad news is good news”, the grim jobs data fuelled hopes of further fiscal largesse. Expectations that the incoming Biden administration will deliver significant stimulus were further buoyed after the Democrats secured control of the Senate with a double victory in the Georgia runoffs. As for the outgoing president, the Donald is facing the prospect of a second impeachment after last week’s obscene scenes at the US Capitol. The end of the toxic Trump era is within sights, but the worry is that he might have a final surprise up his sleeve.
What last week showed is that investors are happy to ignore bearish risks. The fact, however, remains that several parts of the world are in the midst of the tightening grip of a pandemic. Even China is not immune from the latest resurgence after reporting its biggest daily jump in cases in over 5 months overnight. All things considered, the near-term outlook for the global economy and hence oil demand still leaves a lot to be desired. The bottom line is that the oil market is impervious to bad news and something has got to give.
Not-so-happy new year for US oil demand
The oil market’s current focus is on Saudi Arabia and its lower-for-longer supply strategy. Yet it’s only a matter of time before traders turn their attention back to the weakening fuel demand backdrop. Nowhere is this issue more apparent than in the US. According to the EIA, domestic fuel consumption (measured as product supplied) tumbled 12% during the final week of 2020 from the previous week as Covid infection rates soared across the country. Leading the pullback was gasoline. Implied US gasoline demand plunged 687,000 bpd to 7.44 mbpd in the week to January 1, the lowest since April.
And the prospects for the early part of this year aren’t any better. Mobility levels in America’s biggest cities are trending lower as fresh coronavirus restrictions keep drivers off the road. This trend is unlikely to reverse significantly in the coming weeks. In other words, travel will remain weak over the next couple of months. At the same time, casting another dark cloud over the country’s near-term gasoline demand are rising prices at the pumps. US retail gasoline prices are at their highest since the pandemic drove widespread lockdowns last March, according to auto club AAA. This reflects the recent strength in crude prices rather than a demand-induced uptick. Simply put, America is virtually guaranteed to see higher gas prices in 2021, much to the chagrin of motorists.
Amid the latest downturn in US gasoline demand are growing fears of an inevitable shift from fuel inventory draws to builds. And true to form, US gasoline stocks have started to push higher. Stockpiles rose by 4.5 mbpd in the final week of 2020, the biggest weekly gain since last April. This left stocks in the fuel at their highest level since August. That said, at just over 240 million bbls, they are on par with the five-year average for this time of the year. This compares favourably to the hefty 13% surplus to the five-year norm seen back in April. Nevertheless, the fledgling trend of falling gasoline demand and rising stockpiles is poised to continue. In short, excess US gasoline inventories are set to become the norm in 1Q2021.
Needless to say, this will eat into margins. The RBOB-Brent crack staged a recovery throughout December and finished last week at a three-month high of nearly $9/bbl, according to Refinitv data. Now, though, upside potential will be in short supply. This is especially true if refiners continue to dedicate a large part of their operations to producing gasoline at the expense of jet fuel. Mercifully for America’s fuel makers, refinery margins are expected to rise in the second half of 2021. This is on the assumption that gasoline demand will recover as US vaccination programs continue to ramp up.
In the meantime, the positive impact of vaccination rollouts feels like a distant world away. There should be zero expectations for a pick-up in US gasoline demand until the spring at the very earliest. And even then, the gasoline market will still be far from a return to pre-virus normalcy. If anything, the most recent loss of momentum in US gasoline consumption has pushed forward the demand timeline of recovery, a fact that is sure to be reflected in tomorrow’s EIA report.