Downside Risks Remain Despite Oil Price Rebound

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By Amad Shaikh

The last few days have seen money rushing back into oil, with all crude benchmarks climbing furiously, including Brent showing a 14 percent week over week increase, rebounding from a short-lived dive in prices the week before. The super-contango being projected for May/Jun has vanished, with Jun/Jul structure almost flat.

While this strength does have a fundamental backbone in improving supply-demand fundamentals, the rate of increase may also have something to do with global monetary quantitative easing (QE), with the Fed balance sheet at nearly 30 percent of GDP and growing. With equity markets at almost pre-crisis levels and cheap money slushing around, speculators may be looking to move away from treasuries into metals and commodities. This has been true in the past and could well be happening again.

It isn’t all fundamentals however, markets continue to be driven by news cycles, with more unexpected news driving the steeper price changes. Fundamentally last week, there was more good news than had been expected and less bad news. Good news on the supply side included the IEA seeing tentative signs of faster rebalancing from the supply side, with Saudi output dropping to 2002 levels and Iraq reaffirming its commitment to meet the 1 mbpd cut in May-June. In the U.S., rigs fell for the 9th straight week by 20 percent week over week to 370, with Cushing stockpiles declining for the first time since January.

Good news on the demand side included the IEA revising its 2020 demand forecast from a -9.3 mbpd decline to -8.6 mbpd decline, with Goldman upping its May demand estimate by 1.4 mbpd. Also on the demand side, South Korea and China appear to have arrested a second coronavirus wave with Chinese demand seeing a “V” shaped recovery.

But as before, especially in the near-term, buyer-beware: while the oil price rally appears to have priced in almost all the optimistic news, it seems to be ignoring downside risks. For example, high Chinese refinery input may be an artificially bullish signal, as it is creating products beyond organic demand growth in China. Around 50 million barrels of Saudi oil is steaming towards America and threatening to upend the positive supply development. Poor refining margins will prevent any sharp refining throughput gains. And high inventories, both inland and floating (now the highest in history at 200 million barrels) will likely cap further gains in crude prices.

On the demand side, WSJ experts are seeing global recession odds at nearly 100 percent, with the only question around severity. New USA jobless claims went up by 3 million, more than expected, to a total of 36.5 million, and once stimulus measures run out, unemployment will become a significant obstacle to demand. Also, the coronavirus seems to be mutating, with patients in the Chinese provinces of Jilin and Heilongjiang possibly carrying the virus for a longer period of time and taking longer to test negative.

On this final note of caution, and just to keep our memories of what happened to WTI prices last month fresh, Platts announced some changes for Arab Gulf product prices (usually netbacks from Singapore). Essentially, Platts will publish zero or negative numbers only if relevant spot market information confirms that assessment. Let’s hope we don’t have to put this new methodology to test for a long, long time.

Crude Oil

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