Crude oil markets remained optimistic over the past week supported by several bullish factors. Brent spot prices rose above $46 for the first time since April on a much weaker US dollar, with the dollar index plunging below 94, a level that hasn’t been seen since June 2018. The U.S. dollar was beaten down by rising unemployment data and uncertainty over the trillions in economic stimulus. At the beginning of the COVID-19 crisis, the U.S. dollar index was at record high and was viewed as the no.1 safe haven asset, but during the last few months, investors shifted attention to gold, with bullion prices rising above $2000.
Brent closed the week at $44.40 up by 1.98% w/w while WTI closed at $41.22 up by 2.30% w/w. For the month of August, we forecast an average Brent of $45, compared with a forecast of $43 and $40 for the past two months, respectively.
Despite this bullish sentiment, markets continue to be corrected by concerns about the slow demand recovery. Reports reflect rising COVID-19 cases in the United States and in India. In the United States, the number of daily COVID-19 cases rebounded to exceed 55 thousand new cases reported last week. In India, daily cases rebounded to new, unprecedented levels, with authorities reporting more than 65 thousand cases a day last week.
Decline in inventories may slow as driving season ends
In line with bullish sentiment, the EIA commercial crude inventories continued to decline despite rising cases of COVID-19 in the United States. Commercial crude oil inventories dropped by 7.4 million barrels w/w to stand at 518.6 million barrels, which is 79.7 million barrels above its level at the same time last year. Subject to a continued rise in economic activities, a limited impact of a 2nd wave of COVID-19, and 100% compliance to OPEC+ output cuts, we expect commercial inventories to return below 450 million barrels by Q2 2021. The past couple of months netted a decline in U.S. commercial crude inventories, declining by 6.9 million barrels in June and by 32 million barrels in July.
The decline in the U.S. commercial crude inventories was combined with a net rise in crude imports and refining runs, showing positive signs of demand recovery.
Imports rose by 0.864 million bbl/d w/w while exports dropped by 0.392 million bbl/d w/w. The US refining utilisation factor currently stands at 79.6% of the total capacity, 18.4 million bbl/d, this is only 15.23% below its pre-crisis levels. Related: Oil Prices Post Weekly Gain Despite Struggling Demand
Last week, refining runs rose by 42 thousand bbl/d to stand at 14.637 million bbl/d. On the other hand, the EIA reported a rise in gasoline and middle distillates inventories by 0.419 million barrels and 1.6 million barrels w/w, respectively, which may be attributed to the sharp decline in crude inventories.
OPEC+ reaffirms its commitment towards full compliance
The Energy ministers of Saudi Arabia, UAE, Kuwait, and Iraq held a telephone call last week to review market developments and affirm commitment to full OPEC+ compliance. Iraq confirmed that it will cut 400 thousand bbl/d on top of its 850 thousand bbl/d required cuts bringing its total cuts to 1.25 million bbl/d in the months of August and September. It is expected that Iraq’s total production in August and September will average 3.4 million bbl/d. Compliance levels of other African producers is also expected to reach 100% in Q3, especially Nigeria and Angola which managed to achieve 60% and 89%, respectively, in June according to Platts. These factors continue to weigh in the markets as seen in the Monday trading session showing Brent trading well above $44.
Aramco slashes its OSP while delivering resilient results in Q2
Aramco has announced major discounts on its crude grades shipped to NW Europe ($1.8-$2.8), the Mediterranean ($1.1-$2.5) and to Asia ($0.30), while keeping its prices unchanged to the United States for the month of September. Discounts were mainly driven by the OPEC+ production hikes, a rise in Chinese crude inventories, and sluggish demand growth in Europe and in India. It is clear that bigger discounts to NW Europe and to the Mediterranean are a move from the Saudi giant to increase its market share in these markets, and to position its grades to compete against popular blends such as Urals, whose prices have been falling throughout the month of July due to low refining margins.
Aramco has announced its Q2 2020 financial results reporting a net income of $6.6 billion compared to $24.7 billion in Q2 2019 showing a decline by around 73%. Furthermore, a net income in the H1 2020 was reported to be $23.2 billion compared to $46.9 billion in H1 2019, showing a decline by around 50%.
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Given the financial strength of Aramco, it confirmed that it will continue to pay dividends to its shareholders, which currently stand at $18.75 billion (some $5.35 billion higher than in Q2 2019), despite a major decline in its profitability. While most other oil companies reported net losses, with the exception of Shell, we believe a major factor in Aramco profitability are the low operating costs compared to other oil majors, currently in the range of $10-$15/bbl.
By Yousef Alshammari for Oilprice.com
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The second bullish influence is the steep decline in US oil production by an estimated 6.3 million barrels a day (mbd) this year so far according to my calculations as a result of the pandemic compared with a claim by the US Energy Information Administration (EIA) that the decline was only 2 mbd. This loss was totally incurred by the US shale oil industry. As a result, US oil production will be struggling this year and the following years to even reach 6-7 mbd.
A weakening or a strengthening of the US dollar by which most of the oil trade is priced doesn’t help oil prices. On the contrary, it weakens them and I will explain why.
When the US dollar rises against other major currencies particularly major importing countries, it makes oil more expensive thus buyers tend to reduce their imports and this adversely impacts global oil demand and depresses prices. On the other hand, when the dollar weakens, it forces major oil producers particularly Arab Gulf producers to spend more of their earnings to pay for the same imports of goods. To mitigate its impact on their budgets, they, in normal circumstances, tend to increase their production to compensate for loss of income. However, because of the OPEC+ cuts, members of OPEC+ aren’t going to increase their production this time.
How could you say that Aramco has delivered resilient results in Q2 when it only earned $6.6 bn compared with $24.7 bn during the same quarter in 2019. This is a 73% loss of revenue. Still, Saudi Aramco announced that it is going to pay dividends amounting to $18.75 or three times its earnings in Q2.
Even a giant like Saudi Aramco has had to borrow substantially in order to finance its purchase of a majority share in Saudi Petrochemical SABIC. Therefore, instead of paying dividends of $18.75 bn, Saudi Aramco should have cut its dividends to only $3.3 bn, half of its earnings and used the balance to pay off part of its outstanding debts. This, in my opinion, is a better business management rather than borrowing to pay dividends.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London