WTI rose almost 90 percent last month, which is the strongest monthly increase in the U.S. benchmark price ever recorded. Naturally, the news has been cause for joy among those rooting for higher oil prices. But should it?
It is true that demand for oil is improving, slowly, but improving after lockdowns started being lifted in Asia, Europe, and North America. China's oil demand, notably, has recovered to 90 percent of pre-crisis levels, and U.S. demand is also on the rise, judging by rising refinery runs as reported by the Energy Information Administration.
Supply is still being limited, too. OPEC+ started cutting its agreed 9.7 million bpd last month, and despite far from perfect compliance, it has reduced the amount of oil going into markets. U.S. producers also cut production significantly in April and May, and so did Canadian oil companies.
All this undoubtedly contributed to the major improvement that WTI prices saw last month. But there was also another reason for the record-breaking price rise: the fact that before that, WTI had fallen to lows also never seen in history. The swing into the negative on April 20 was an unprecedented event as well as a one-time event. The reason WTI swung into the negative was traders selling out of oil to avoid physical delivery. There was little chance this could happen again despite the Commodities and Futures Trading Commission warning about it in May.
"The lower you fall, the higher you'll fly" says Chuck Palahniuk, and this has been true for WTI in May. There was no way the benchmark could remain near zero after dropping to below -$37 a barrel in April, not when producers were scrambling to shut in wells, canceling contracts, and generally retrenching. Not when the repeated warnings of analysts that the global oil storage is filling alarmingly fast prompted Saudi Arabia to cut an additional 1 million bpd on top of what it had already agreed to cut under OPEC+ quotas. Related: Saudi Arabia And Russia Agree To Extend Production Cuts
This is why this historically fast price rise could be misleading. For all the hype oil demand improvement has been getting, it has yet to recover fully, and nobody—including the oil industry—knows if it will recover fully. It is yet unclear whether OPEC+ will extend its deepest cuts beyond the end-June expiry.
The latest reports here are conflicting, with some sources saying Russia and Saudi Arabia have agreed on extending the cuts and others saying Russia is, in fact, in support of the idea to follow the original agreement and ease the cuts to 7.7 million bpd from July. Yesterday, OPEC+ sources said Russia and Saudi Arabia had agreed to extend the deep cuts by one month, but it has yet to be announced officially.
What's more, U.S. shale producers are beginning to restart their shut-in wells. This is a necessity for many of them: the longer a well stays shut-in, the higher the risk of losing production. But this means production will be coming back when storage facilities are still full. Demand simply cannot recover this fast, and fuel inventories are proving it: for two weeks now, gasoline and distillate fuel inventories have been rising, with the latest weekly data showing a 2.8-million-barrel rise in gasoline and a 9.9-million-barrel increase in distillate fuel stockpiles.
The global picture is not rosier, either. More than a billion barrels of unsellable crude sits in storage facilities around the world, Bloomberg's Grant Smith reported earlier this week. Production may be lower, but these barrels are going nowhere anytime soon.
"Even with a conservative view -- assuming a recovery in demand and OPEC sticking to the deeper cuts -- it will take until the middle of next year to reverse the inventory build," BNP Paribas' head of commodity strategy Harry Tchilinguirian told Smith. And this means continued pressure for oil prices, despite the record May gain for WTI.
By Irina Slav for Oilprice.com
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The proof is that oil demand in the world’s three biggest consumers is virtually returning to pre-COVID-19 levels with China hitting 92% of normal demand in May and India set to reach normal demand level by June with the United States’ gasoline demand rising by a 7% week-over-week increase.
The speed by which the global oil demand is recovering is underpinned by the almost certainty that OPEC+ is going to extend the production cuts for at least 1-2 months, the accelerating easing of the global lockdown, China’s surging crude oil imports and the steep decline in US oil production estimated to have hit 4 million barrels a day (mbd) in May. This all means one thing: a re-balancing of the global oil market is taking place with the glut starting to decline.
However, a bearish factor lurks behind the scenes, namely a resumption of the trade war between the United States and China. However, the US economy has been weakened so much by the coronavirus outbreak to be able to wage another trade war against China soon. China’s economy has stolen a march on the United States' and other leading economies by exiting the lockdown first and is already reaping benefits from this.
That is why the outlook for oil looks promising with prices projected to hit $45-$50 a barrel in the second half of this year and touch $60 in early 2021.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London