This week we hit some milestones in the year-long recovery from the oil demand crash of 2020. West Texas Intermediate, (WTI) hit and moved past the $55.00 level, and Brent moved closer to $60. These are some important psychological barriers for the market, and if sustained, as we expect they will be, will push prices higher.
The API announced a significant draw of ~4.3 mm barrels in crude stocks yesterday when a modest build was expected. Moves lower in gasoline and distillate stocks bolstered this price move, as it suggested refineries were cranking out product to meet present and anticipated demand.
In recent weeks oil prices had been resistant to adverse data (inventory builds of crude and refined products) and had continued to inch higher. The market’s relief at this confirmation of demand pushed prices for WTI through that critical $55.00 threshold.
If the EIA confirms this move today, (these reports are sometimes contradictory), we expect another push higher for both crudes, WTI and Brent. Particularly if the confirmation is of significant proportions, like 8-10 mm barrels. Continued price advances in crude will soon reverse the sluggishness we have seen in the oil equities market. Oil equities prices are typically off 15-20% from recent highs in an apparent disconnect from the recent strength in the underlying data regarding oil.
Crude stocks are falling into the 5-year range
Last week’s ~9.9 mm bbl draw moved the supply graph back into the 5-year average for the first time since mid-2020. This removes another psychological barrier for the continued rise in crude prices, as the market will now begin to shift its concern from inventory overhang to worrying about secure supplies. I discussed this in detail in an OilPrice article last month.
The EIA also noted an increase in refinery throughput for the previous week, which is not something you expect this time of year. That said, we are still off about 2-mm BOPD from a year ago. This increase is bullish for prices as it implies rising demand at the retail level.
U.S. Production is starting to fall
Crude oil production thanks to Drilled but Uncompleted, (DUC’s) withdrawal has levitated around 11.0 mm BOEPD for the past month or so. This, in spite of the level of new drilling, (although on the increase), still not being at a level that will totally offset field decline rates, (6-40% per annum). Domestic crude production is down 2.3 mm BOEPD from its all-time high set in March of 2020, at 13.1 mm BOEPD.
This week the EIA reported a modest decline of 100K BOEPD to 10.9 mm BOEPD. Taking place in the lower 48, as noted by the EIA report, it’s not a stretch to connect this decline to falling shale production. We will have an additional guidepost when the EIA publishes its Drilling Productivity Report, (DPR), the next iteration of which is due February, 16th. Last month’s report forecast a decline from shale fields of ~89K BOEPD in February.
Looking ahead to the rest of 2021
The key indicators are in place for a continued increase in oil prices, as we have noted so far. One of the questions we now have to tackle is what can we expect in terms of pricing, and how fast might this happen?
Goldman Sachs, (NYSE:GS), has recently called for $65 Brent by mid-year. With the narrow spread ($2-3.00) between Brent and WTI in recent times, this would put WTI into the low $60’s. Goldman’s global head of commodities research, Jeffrey Currie, said in a note that accompanied the report-
“With vaccines being rolled out across the world, the likelihood of a fast tightening market from 2Q 2021 is rising as the rebound in demand stresses the ability of producers to restart production.”
The advent of this report moves Goldman’s forecast for the attainment of the $65.00 level by about months. With the conservative tone of previous Goldman reports, it’s likely that this also errs to the conservative side, meaning that mid-year provides them with some cushion for the relevant forces to play out. The chief relevant external force being the roll-out of the Covid vaccine and new infection and hospitalization rates continuing to decline.
My expectation is that even with the increase in drilling and fracking taking place we shouldn’t expect sustained pricing over $60 for WTI before Goldman’s estimate of mid-year as there are bearish forces also in play that could put a damper on the rise.
Key countervailing forces that might dampen the market’s enthusiasm
The Saudis gave the oil market a gift early in January with the announcement that they were going to withhold another 1-mm BOPD from the market. As prices rise there is going to be pressure internally and externally from OPEC+ to start restoring production. This is baked-in though, meaning that this master-stroke that turned an already rising oil market on its ear, so-to-speak, was always going to be a transition move.
So with rising oil prices, the chances increase that the Saudis and OPEC+ will shift from supporting prices with restrained production to protecting their market share from competitors.
That move which we anticipate is not far in the future will act to slow inventory declines, which will keep prices from spiking too sharply in the near future.
Moving on we have China which almost single-handedly supported oil prices with its massive purchases last year. Estimates vary but China’s buying of cheap crude last year may give them a ~300 mm bbl cushion upon which to draw if prices rise too quickly.
Finally, there is an expectation for Iran to cut some kind of deal with the new political regime in the U.S. to restore full production. There aren’t any signals from the Biden administration as to just how pressing coming to some accommodation with Iran is on their agenda. That said, re-entering the Iran nuclear deal was a campaign bullet, so some relief is on the horizon for them.
There are more bullish forces at play than bearish in my estimation, and the push higher for crude should continue. The key points supporting that contention are the declines in storage that we have documented here, and the current roll-over in new production to below 11.0 mm BOEPD. If those continue, as we expect they will thanks to a recovery led by declines in new Covid infection rates, crude has no alternative to going higher as the year advances.