Oil Rally Stalls As Oversupply Threat Grows

Following the price rally seen last week, oil prices have retreated to slightly lower levels, below $70 (Brent) and $64 (WTI).

The main drivers of this correction have been the build-up in US oil inventories for a second consecutive week by 13.8 million barrels w/w, which is attributed to the continued closure of many refineries on the Gulf coast.

The outages continue even this week as refineries on the gulf coast continue to operate below their full capacity. Refineries on the gulf coast are currently 2.59 million bpd below their processing levels a year ago, the hardest affected among refineries elsewhere in the US. Furthermore, total crude input to refineries is 3.39 million bpd below its levels a year ago which was attributed not only to the COVID-19 pandemic but also to the oil freeze seen in Texas last month. For instance, we can see that gasoline and diesel inventories declined by 11.9 million barrels w/w and 5.5 million barrels w/w, respectively. Currently, US commercial oil inventories are 46.6 million above their levels before the pandemic. Furthermore, US production rose by 900,000 bpd w/w to stand at 10.90 million bpd.

Prices were also affected by the concerns of the rising number of COVID-19 cases in Europe where lockdown measures are extended in key economies such as Germany, Italy, France and the UK. The suspension of vaccinations with the Astra-Zeneca jab in many European countries is also raising concerns about the safety and availability of COVID-19 vaccines. The World Health Organisation just announced that there could be a possibility of a third vaccine dose to counteract new variants of the virus. 

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Furthermore, there has recently been a rebound in the US dollar index which trades above 91 ahead of the Fed meeting this week which will be revising the interest rates. Further delays in hiking interest rates may lead to stimulating economic growth in the US which will consequently support oil prices further in 2021.  

High prices are hurting demand in India

The current rise in oil prices has triggered concerns among Indian refiners, which are considered to be the world's second largest oil importers right after China. Oil demand is said to have declined by around 5% last February and Indian refiners were instructed to diversify sources of their crude intake. India is one country which has been particularly unhappy with the last OPEC+ decision not to increase production, which sent crude oil prices rising during a period of economic recovery and relatively low oil demand. India is expected to post the largest energy demand growth in the next 20 years with an expected rise in oil demand from 4 million bpd to 8.7 million bpd in 2040. India has conventionally relied on the Middle East for more than 60% of its crude imports. Yet, it is currently trying to curb it purchases, importing crude from the US and Latin America. This strategy, however, may prove to be risky given the shipping distance, ease of production, and the quality of crude.

A longer term bearish risk for crude is that US shale oil production is expected to return if we continue to see higher crude prices for an extended period of time. So far, shale oil producers have remained disciplined focusing on maintaining production flat while generating decent returns for their shareholders while reducing debt levels. This perhaps has been a key consideration for the OPEC+ decision made beginning of this month.  Related: Are Analysts Underestimating Chinese Oil Demand?

OPEC continues to be cautious in its demand outlook 

Given the bullish price outlook for 2021, OPEC expects non-OPEC supplies to increase by 1 million bpd y/y to average 63.9 million bpd with the largest rise expected to come from Brazil, Norway, Canada, and Russia. 

Due to the economic uncertainty surrounding new variants of COVID-19, efficiency of the vaccines, OPEC has revised down its demand forecast for H1-2021 to be 96.3 million bpd up by 5.9 million bpd y/y. Furthermore, the OECD crude oil stocks currently stands at 46.3 million barrels above the latest five-year average, and 61.3 million barrels above the latest five year average before the pandemic 2015-2019. Most of the excessive levels continue to be in US crude oil inventories. 

Compliance levels with the OPEC+ output cuts have also been very bullish for the month of February. According to Platts, compliance stands at 113.54% which is largely due to the voluntary cuts made by Saudi Arabia whose compliance stands at 152.58%. Furthermore, Russia achieved a compliance of 100.22% with a production standing at 9.18 million bpd. Iraq and Nigeria continue to be falling behind their compliance targets, exceeding their quota by 40,000 bpd and 30,000 bpd, respectively, in the month of February. Furthermore, production from the countries exempted from the OPEC+ agreement, Iran, Libya, and Venezuela remains almost unchanged at 2.14, 1.13, and 0.55 million bpd, respectively. 

By Yousef Alshammari for Oilprice.com

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