Oil Rally Unlikely To Be Derailed By Supply Side Risks

Despite trading at above $74, Brent prices retreated following the comments made by the chairman of the Federal Reserve which gave a boost to the US dollar.

The Federal Reserve seems to have realised that inflation levels may end up higher than previously anticipated, as shown by the historical lows of the bond yields, weakening US dollar, and significant rise in equity markets. The comments made last week, made by Jerome Powell suggested that inflation may not end up as being 'transitory' and that the Fed, which is still concerned about the job data, may decide to hike interest rates twice through 2023.

The US Federal Reserve has been keeping interest rates low to support economic growth, yet its meeting last week was seen as a hawkish surprise. U.S. inflation is currently seen at 5% and there is a risk that it may not end up being transitory as was expected by the Fed. Many prominent economists including Mohamed El-Erian warned that the Fed is continuing to fall behind the curve, with 10-year bond yields reaching breakeven points. Reacting to the Fed meeting, the US dollar index closed at 92.21, last Friday, up by 1.8% w/w.

Yet, there is still a continued optimism among many analysts driven by demand recovery and expectations of rising inflation in the United States. Last Friday, Brent prices closed at $73.51, up by 1.12% w/w, while WTI closed at $71.64, up by 1.02% w/w. Various factors have been contributing to the continued rally in prices including easing of lockdown restrictions in Europe, an increase in international aviation movements, the decline in crude oil inventories, and relatively steady U.S. crude production. Total U.S. oil production continues to be within the 10.9-11.2 million bpd range since the beginning of this year, which is a major reason why Brent prices are trading above $70. Traders continue to bank on a 5 million bpd demand recovery in H2 2021, resulting mainly from the recovery in jet fuel demand, while many trading firms including Trafigura and Vitol are now predicting $100 oil in 2022. Related: It's Too Late To Avoid A Major Oil Supply Crisis

COVID-19 and a return of Iranian crude continue to weigh on the markets 

Despite the bullish sentiment, the rally in crude prices may be capped by concerns of a new strain of COVID-19 and the return of 3-4 million bpd of Iranian crude oil to the market, both of which could keep oil prices from breaking out during the second half of 2021. Despite easing restrictions in many countries around the world, COVID-19 continues to weigh on the demand-side with the delta variant expected to be the dominant version in the world this summer, according to John Hopkins University. This new strain of COVID-19 may warrant new vaccine boosters along the way. Furthermore, as many developing countries continue to have limited or no access to vaccines, the risk remains that the new COVID-19 variant spreads to other countries especially if international aviation activity picks up. The delay in opening the economy in the UK is one example of the persistent concern of COVID-19. Adding to the supply-side uncertainty, the electoral victory of new Iranian president, Ebrahim Raisi, who faces US sanctions himself, could delay the Vienna nuclear deal negotiations between Iran and Western powers.

Related: Is OPEC+ Ready To Open The Taps?

IEA outlook may turn out to be too bullish 

The latest data from the IEA shows that oil demand may average 99.6 million bpd by the end of 2021, which is almost equal to the 2019 oil demand, and in our view, this forecast could end up being too bullish. This is due to the fact international travel continues to be complicated, and many countries continue to have their borders closed for tourism, while business travel is not expected to recover until at least mid-2022. 

The IEA has asked OPEC+ to increase supply during the second half of 2021, expecting that crude oil demand will average 99 million bpd in Q-4 this year. Yet, the Saudi Energy Minister has indicated in his speech at the Wall Street Investors Conference that the OPEC+ cautious approach has brought key benefits currently observed in the markets, in particular, the return of crude inventories to pre-pandemic levels.

The latest figures from the EIA show that commercial crude inventories have returned to pre-pandemic levels, and are currently standing at 466.7 million compared with 483.3 million at the same period in 2019, which is not far from our last year forecast of 450 million barrels. A further decline in inventories is expected as we continue to see high demand during the summer season. There has also been a major uptake in U.S. crude oil refinery throughput, which has risen to more than 16.34 million bpd, with gasoline demand reaching 9.36 million bpd, compared with 9.93 million bpd at the same period in 2019, both of which explain the drawdown in crude inventories. U.S. oil production last week was reported to be 11.20 million bpd, up by 200,000 bpd w/w, which was accompanied by a relatively small rise in the number of the U.S. oil rigs which rose by 8 to 373, up by more than 100 rigs since the beginning of this year.

By Yousef Alshammari for Oilprice.com

More Top Reads From Oilprice.com:

• $100 Oil Predictions Soar As Analysts Warn Of Supply Crisis
• The Real Reason Big Oil Is Giving Up On Iraq
• Oil Prices Hit Multi-Year High Following Iranian Elections