The sluggish global oil demand recovery is putting off the point of oil market rebalancing and adding downward pressure on oil prices. At the end of the first half of 2020 in June, many analysts and experts predicted that the global oil supply-demand balance would be in a sharp supply deficit in the third and fourth quarters this year.
While there have been inventory drawdowns in recent weeks, including in the world’s most visible market, the United States, demand has failed to recover as much as analysts had predicted two months ago.
Combined with OPEC+ group’s struggles on the supply side to rein in laggards in compliance who continue to overproduce above their quotas, oil prices have struggled to break above the low $40s amid those bearish fundamentals.
Over the past month, analysts, OPEC, and the International Energy Agency (IEA) admitted that their earlier forecasts of global oil demand this year may have been too optimistic. Both the IEA and OPEC revised down their oil demand forecasts in their respective reports in August, pointing to still struggling fuel demand and continued high uncertainty about the pandemic’s impact on economies and mobility.
The OPEC+ cuts may have stabilized oil prices, but the slower-than-expected oil demand recovery continues to weigh on prices and market sentiment.
OPEC itself said after the monthly meeting of its panel reviewing the situation on the market that “the pace of recovery appeared to be slower than anticipated with growing risks of a prolonged wave of COVID-19.”
The oil futures already reflect the market’s view that rebalancing is still some time away.
In recent weeks, the contango—in which prices for delivery at later dates are higher than front-month prices that typically points to oversupply—has deepened to more than $2 a barrel for the Brent Crude futures between November 2020 and May 2021. The six-month calendar spread was in a contango of only $0.48 a barrel as of the middle of June, according to estimates from Reuters market analyst John Kemp.
The contango in the Dubai crude Middle East benchmark, which appeared at the end of July, deepened in August as refining margins in the Asia Pacific region stayed weak amid a resurgence of COVID-19 cases, Argus notes.
The perceived oversupply in the market and demand recovery going at a weaker pace than initially thought (or even stalled) have had money managers increase their bets that Brent and WTI will drop. Hedge funds have boosted their short positions over the past two months, Reuters’ Kemp estimates.
The fundamentals are not constructive for an oil rally right now, but prices have been supported by a weak U.S. dollar in some of the recent trading days.
In fact, one analyst, Vandana Hari, founder of Vanda Insights, told CNBC earlier this week that a weaker dollar was the only support to oil prices.
Later in the week, a sudden strengthening of the dollar pushed oil prices lower, adding to the general sell-off in equity markets that also weighed on commodities.
“The much-needed correction following months of stale trading has been led by dollar strength, stock market weakness and a faltering COVID rebound in global fuel demand,” Steen Jakobsen, Chief Investment Officer at Saxo Bank, said on Friday.
“Not helped by the fact that the US Labor Day holiday on Monday signals the beginning of the low demand period. The next levels in terms of support are the July lows at $38.75/b on WTI and $41.40/b on Brent,” Jakobsen said.
Faltering demand recovery and the resulting slower supply-demand rebalancing will continue to weigh on oil prices in the near term.