By Irina Slav
Things have been happening increasingly fast in the oil industry, especially with prices. With so much volatility around, price movements are quick and often surprising. Right now, the general optimism on oil markets is in decline, because of the latest price rally. It may sound counterintuitive, but it is, in fact, easy to explain. The prices of Brent and West Texas Intermediate have doubled since April. In the case of WTI, the rally was a lot higher than a doubling, too, if we take into account the swing below zero. As a result of this rally, there are already reports that U.S. shale oil producers are restarting shut-in production, and there are opinions from senior energy officials from OPEC+ members that the market is due for a deficit before the end of this year.
Such opinions should have been bullish for oil, pushing prices even higher. Yet this hasn’t been the case. In fact, according to Reuters’ John Kemp, hedge funds have sharply reduced their oil contract buying. In his latest column on the topic, Kemp noted that funds had only bought 6 million barrels in the week to June 2. This was the lowest level of buying for the last nine weeks, Kemp noted.
The expectation that U.S. shale drillers need just a little bit of push to start pumping more again must have been part of the changing sentiment. Another part was probably the disappointment that OPEC+ did not extend its deep production cuts for more than a month. OPEC may have discussed the option of a longer extension, but public reports did not mention it. Yet traders apparently expected a longer extension and remained unmoved by the actual extension, their sentiment reflecting on prices and barely moving them up.
What’s more, there may be more bad news on the horizon. In a note earlier this week, Morgan Stanley said that the current oil price rally wouldn’t be a lasting one.
The bank said this rally “appears mostly supply- rather than demand-driven, and it is questionable how strong refinery runs can increase against this backdrop.”
Indeed, we have yet to see how demand improves across the world, although the latest oil import and refinery run data from China is certainly encouraging. Oil shipments into the world’s largest importer hit an all-time high last month, at 11.34 million bpd, according to official customs data. Traffic figures from TomTom supported the impression of a strong recovery, suggesting that fuel demand was also on the rise.
The question remains, however, how long will it take for this demand improvement to spread and will it be sustainable. Another question that is important in this context is when China will stop buying record amounts of crude. After all, refiners and traders spent the lockdown months stocking up on cheap—a lot cheaper than it is now—oil. The state also filled its oil reserves. In other words, China may have insulated itself from sharp oil price jumps for a while, at least. If prices rise too high, it will reduce buying, and this will pressure prices.
But there is another perspective, too. A drilling industry executive told media last week that WTI could jump to as much as $70 in a few months because U.S. producers cut output too much too fast, which will cause a “mini-supply shock” on the local market. WTI has not traded at $70 or above since 2018.
There are a lot of scenarios for oil, and when there are a lot of scenarios, traders get jumpier than usual, especially when every scenario has a relatively equal chance of playing out. With so many uncertainties still surrounding the coronavirus that prompted the lockdowns, which drained oil demand, and will uncertainties around the economic recovery of major oil consumers, price volatility will remain excessive. That’s about the only thing that is certain right now. Where prices will be tomorrow, on the other hand, is anyone’s guess.