With just 100 days until the US Presidential election, Donald Trump’s troubles have taken a turn for the worse. The COVID pandemic continues to spread like wildfire across America as virus infections surpassed 4 million. Deaths topped 1,000 for a fourth day in a row on Friday and capped a grim week for the Donald. Underscoring the gravity of the crisis was a shift in rhetoric from the US President in which he warned that the pandemic will worsen before it gets better. All the while, mixed US economic signals cast doubt over the strength of the recovery. Upbeat housing data and a rebound in business activity were overshadowed by disappointing jobs data. US jobless claims registered their first weekly rise first in four months. This is the clearest sign yet that the surge in coronavirus cases is stifling America’s economic recovery.

Alongside these domestic woes was trouble abroad following a fresh clash with China. Tensions between both sides have been brewing for a while and intensified last week after Washington ordered the Chinese consulate in Houston to close. Days later Beijing gave the US diplomatic mission in Chengdu its marching orders. Tensions are likely to remain heightened given the spectre of a further escalation in tit-for-tat retaliatory responses.

Rising geopolitical tensions coupled with economic uncertainty and an unprecedented health crisis do not make for a supportive back for risk assets. Small wonder, then, that the S&P 500 snapped a three-week winning streak last week, though the pullback was modest. The downside was capped by a flurry of promising vaccine trials and expectations of another injection of fiscal support from Washington. The current COVID relief package is due to expire on Friday and financial markets and eagerly bracing for their next stimulus fix.

Oil, meanwhile, put on choppy display. Brent and WTI initially hit four-month highs as bulls took heart from a weary dollar. Yet they gave up most of these gains as demand concerns resurfaced. The upshot is that both crude markers ended the week with only marginal gains. The former notched a weekly advance of 20 cts/bbl ($43.34/bbl) while the latter tacked on 70/cts bbl ($41.29/bbl). There was, however, one clear winner from last week’s decidedly risk-off feel to financial markets. Gold rallied hard and topped $1,900 for the first time in nine years as jittery investors sought protection in these unprecedented times. This morning, the yellow metal has hit a record high. Simply put, caution reigns supreme.

Contango-itis 

“Contango is set to become the norm for 2020.” The concluding sentence from this report dated May 4th of this year still rings true. Prompt Brent timespreads flirted with backwardation this time last month but have steadily weakened in July. The M1/M2 Brent spread settled at -44 cts/bbl on Friday compared to -7 cts/bbl at the turn of the month. Meanwhile, the contango on the equivalent WTI spread has also deepened, albeit to a lesser extent, having been entrenched since January.

The near-term structural weakening comes as supply-led bullish factors start to unwind. First and foremost, record OPEC+ cuts are being reined in. The producer alliance is loosening the leash on supply curbs as demand recovers. And it is not alone in gradually reopening the oil spigots. US shale producers are bringing back curtailed production as prices recover. At least a third of the 2 mbpd production shut in since April is expected to return to the market. US oil production rose by 100,000 bpd in the week to July 17, the first weekly gain since March baring a post-hurricane rebound. Likewise, drilling activity is starting to show signs of life following a protracted downturn. US drillers added their first rig this week in four months, according to data from Baker Hughes.

Not wanting to be left behind, Canada is also getting in on the act. Swathes of Canadian crude are coming back online after producers curtailed some 1 mbpd – about 20% of the country’s output – in response to the coronavirus pandemic. Western Canadian oil companies are set to restore all output cuts by the year-end, according to the head of Suncor. Supplies are also rising on the other side of the Atlantic Basin. Norway has trimmed its production cuts to 134,000 bpd this month from 250,000 bpd in June.

Yet it’s not only this flood in fresh supply that is weighing on prompt timespreads. The surge in COVID infections has put oil’s backwardation ambitions on the back burner. Global cases passed 16 million as the WHO reported another record daily increase in infections on Friday. The worsening pandemic has stymied the recovery in fuel demand across major oil-consuming nations, and none more so than the US. As we mentioned earlier, the number of new cases in America has accelerated spectacularly. In what is a prescient warning, US gasoline consumption, a bellwether for the economy, has shrunk in the past two weeks, according to EIA data.

The second wave in COVID outbreaks is putting the brakes on the rebound in global oil demand. What is more, given the uncertainty surrounding the trajectory of the pandemic, the risks for the oil demand outlook are firmly skewed to the downside. In short, the recovery in demand will turn out to be slower than expected. This new reality will force a rethink on the part OPEC/IEA/EIA triumvirate. They have made a big hoo-ha about the rebound in global oil demand in the current quarter after the history plunge in 2Q20. But their demand forecasts now appear overly optimistic given the worsening pandemic.

Consequently, though the oil market will shift from a substantial surplus to a deficit in 2H20, stock draws will undershoot expectations. In other words, it will take longer to burn off excess supplies accrued earlier this year. OECD commercial oil stocks rose by more than 300 million bbls in the first five months of the year, according to the IEA. As a result, the surplus to the five-year average stood at 258.5 million bbls at the end of May. Only when these stock levels normalise can a shift into backwardation of the forward crude curve be expected. Until then, Brent and WTI will remain on the contango-itis ward.