Oil prices have climbed nearly uninterrupted since late April, but the gains could be coming to an end. On Friday, oil prices fell sharply, hitting the pause button on a rally that saw WTI rebound from -$37 per barrel on April 20, to nearly $34 per barrel on May 21, a more than $70-per-barrel swing in just a few weeks. Of course, the plunge deep into negative territory was likely a unique, one-off phenomenon. Nevertheless, the rally back into (positive) $30 territory has been impressive.
Of note, China’s oil demand has climbed back to about 13 million barrels per day (mb/d), a swift rebound that undergirded improving market sentiment. With China’s demand back to about 90 percent of pre-pandemic levels, oil traders are clearly holding out hopes of a quick rebound elsewhere.
Meanwhile, the rapid shut in of production in North America combined with the OPEC+ production cuts has meant that the supply side of the equation is doing its part. More than 2.2 mb/d of U.S. oil production has been shut in, according to comments from the U.S. Secretary of Energy, a faster curtailment than expected. There has been a raft of investment bank forecasts that have predicted a supply deficit in the second half of 2020.
But the optimism surrounding the oil market, such as it is, may be going too far. On Friday, the Chinese government said that it would not offer up a GDP growth target for 2020, highlighting the serious challenges facing the world’s second largest economy. Beijing pointed to “great uncertainty” because of the coronavirus. The government also declined to undertake massive government stimulus in the same way that it did in the wake of the global financial crisis a decade ago.
Rising tension between the U.S. and China are also weighing on global markets. For political reasons, the leadership in both countries are blaming the other for the coronavirus. The spat could fuel more conflict, perhaps unraveling the “phase 1” trade deal or provoking some other trade retaliation.
In the U.S., crude inventories fell by 5.6 million barrels last week, a huge draw, but gasoline stocks actually increased, muddying the outlook. “After weeks of rising, US gasoline demand was down again for the first time. Demand (for oil products) also remains very subdued elsewhere,” Commerzbank said in a note on Friday. “With concerns on the demand side remaining we regard the latest price rally on the oil market to be excessive.”
At the same time, the run up in oil prices occurred alongside a buildup in speculative bets on oil futures. That helped fuel price gains, but it also exposes the market to a correction back in the other direction. “The extremely positive positioning of investors, especially in WTI, makes the oil market susceptible to price corrections in the event of any emerging doubts and uncertainties,” Commerzbank said.
Most importantly, despite assurances from Trump administration officials, a V-shaped recovery is extremely unlikely. President Trump has repeated this prediction, saying just days ago: “I think you’re going to have a ‘V.’ I think it’s going to be terrific.”
His top economic adviser Larry Kudlow has said the same, although he dialed back the optimism on Thursday while trying not to disagree with his boss.
Sure, the U.S. will see a V-shaped recovery, Kudlow said, but the “V” might not look exactly like a V. “You can have your own Vs. There’s Vs. There are lesser Vs,” Kudlow said. “There are combos of Us and Vs.”
With more than 38 million people applying for unemployment in the past two months, and the pandemic still raging, a fully recovery is a long way off. “[F]ew traders are pricing in any significant sustained global recession,” Standard Chartered said in a report. “All that optimism has, in our view, left prices slightly above the top of their sustainable short-term trading range.”
At the same time, there is little reason to think that the U.S. or any other country can avoid a second wave of infections after reopening.
“A second wave is not such a remote possibility and a new round of lockdowns could send [oil] prices back to much lower levels very quickly, and the market knows it,” Rystad Energy said on Friday in a statement. “Therefore lower prices this morning are not a surprise, and they are not necessarily the result of a market event, they are rather a correction of the consecutive boosts that oil has seen over the last days.
Still, the data firm said that it sees oil stabilizing in the $30-$35 range, with “potential in the 40s” only later in the year “when and if demand strengthens and approaches pre-Covid-19 levels.”