Investors’ optimism is remarkable. The war against the pandemic has not been won, it is dragging on, yet looking back at April it appears that its devastating impact is safely buried in the unconscious part of our minds. The stellar performance came despite global infection rates are still high, India cannot breathe, and other parts of the world are still under enormous pressure to contain the spread of the virus. Of course, the vaccine roll-out is gathering pace in the developed part of the world and this has provided a solid base for last month’s stock market performance. This is an uneven recovery from the health crisis and the market refuses to focus on the negative side of it.
Nowhere the success of the inoculation programmes is more tangible than in the US. Its economy is roaring (1Q GDP rose 6.4% annualized) and its unemployment rate edged down to 6% in March. These improvements are coupled with continuous monetary easing from the US central bank and a series of stimulus measures from the administration, both of which underpins the prevailing confidence.
After the $1.9 trillion Covid relief package successfully passed the Congress in March Joe Biden immediately started to concentrate on his American Jobs Act, a $2.3 trillion programme to upgrade ailing US infrastructure, including roads, bridges and broadband. This is, however, not the end of the journey. In his first speech in the Congress, he wrapped up his first 100 days in office by proposing the $1.8 trillion American Families Plan, that would provide funding for childcare and two free years of community college, would subsidise health cover, would create a national family and medical leave programme and would incentivize female participation in the labour market.
These programmes are planned to be funded by raising taxes. The US corporate tax rates would increase from 21% to 28%, top marginal income tax would be raised by 2.6%, capital gain tax would nearly double, and a loophole in paying inheritance tax would be closed. These proposals will meet fierce opposition from the Republicans despite significant support from the public and the president faces an uphill battle to implement them. Opponents warn of serious economic consequences of the tax hikes whilst Democrats are confident that the re-distribution of wealth in its proposed format will narrow inequality and therefore will bring economic benefits to Americans.
The seemingly solid economic foundation brought encouragement for the commodity sector. Such was the confidence in stable economic growth for the months ahead that commodity indices actually outperformed oil in April. The Refinitive/Core Commodity CRB index, for example, returned 8% to investors whilst Brent edged only 7% higher. The Goldman Sachs Commodity Index gained 8.23% compared to the performance of its energy sub-index of 7.14%.
Oil’s positive conduct was also the result of the brighter economic outlook. It is reflected in the monthly supply-demand data from the three major agencies that project a massive jump in global oil consumption in the second half of the year. OPEC, for example, sees a 3.51 mpbd rise in global oil demand for 2H of 2021 from the second quarter. Consequently, the call on their oil will grow from 26.84 mbpd to 28.62 mbpd during the same period. These figures provide the basis of the gradual 2.1 mbpd tapering of output constraints announced by the OPEC+ group at the beginning of April and confirmed last week. Further, albeit temporary, price support came from the brief closure of the Suez Canal at the beginning of the months and from the Libyan force majeure of oil exports due to budgetary dispute between the country’s NOC and its central bank.
These forecasts naturally led to sanguine price estimates. Goldman Sachs has predicted a Brent price of $80/bbl by the summer based in the “biggest jump in oil demand ever, a 5.2 mbpd rise over the next six months”. This ambitious price forecast has more or less been in line with our view, but recent developments could indicate that the expected price rise over $70/bbl could take longer than anticipated. The reason is twofold.
The first one is the progress on the Iranian nuclear negotiations. Talks have been ongoing for two weeks now and the Iranian semi-official news agency reported over the weekend that a consensus has been reached over lifting sanctions on the country’s energy, autos, financial and port sectors, something that has been quickly refuted by the US Administration. Whilst we do not expect an agreement and therefore increased Iranian oil exports at least until after the Iranian presidential elections in the middle of next month any progress in the nuclear talks will have a profound impact on market sentiment.
The second and more important development is the relentless rise in in Covid infection rates in India, Brazil, Turkey, and several other countries. According to the World Health Organization, new infections last week surpassed the total number of infections in the first five months of the pandemic. The situation is the most critical in India, the main engine of global oil demand growth. Daily new infections are around 400,000 and the death toll is approaching 4,000 a day. The Indian government has been reluctant to introduce a nationwide shutdown nevertheless the country’s economic growth that was pencilled in at well above 10% will inevitably suffer and this will have a negative effect on oil demand growth. April fuel sales were down 10% on the previous month. The untameable rise in infection rates could ultimately force the government to lock down the whole country, in which case as much as 400,000 bpd of oil demand could be lost this year, Energy Intelligence reckons. The situation could get worse if neighbouring countries, Pakistan, Bangladesh, and Indonesia will face the same fate as India due to the spread of the virus. Add to that the potential 1-1.5 mbpd increase in Iranian oil production and the lion’s share of 2H increase in OPEC call could be wiped out. This is, of course, a worst-case scenario. Successful inoculation programmes elsewhere and the efficiency of available vaccines are helping oil prices stabilize around the current levels but the second wave of the health crisis in India might delay the long-awaited rally above $70/bbl by a month or two.