Oil Market Optimism Is Entirely Misplaced

Optimism is supposedly back in oil markets, with the Global Research team at Bank of America lifting its oil price forecast for this year and next as demand recovers from coronavirus-linked shutdowns, the OPEC+ output cut deal curtails supply, and producers slash capital expenditure. The bank now sees Brent crude oil averaging $43.70 per barrel in 2020, up from a previous estimate of $37. In 2021 and 2022, the bank forecasts average prices of $50 and $55 a barrel respectively. BofA also forecast that “a pattern of falling inventories across most regions should emerge as we move into H2 2020. As a result, we expect the full Brent crude oil curve to return into backwardation by year-end”. Norwegian consultancy Rystad Energy, however, has warned that the downside risk in oil markets is still very much alive. In its weekly webinar, Rystad’s Head of Oil Markets, Bjornar Tonhaugen stated that “Brent prompt futures are under pressure this morning with bearish traders selling below US$40, in a reminder that not all is well yet in the market”. He also indicated that while mainstream analysts are optimistic and see a recovery and upward potential for oil, the short-term reality is far from certain.

When looking at the foggy picture currently being painted by the news, publications, and facts on the ground, the only real conclusion that can be drawn is that the ongoing price rally is not yet based on market fundamentals. The ongoing demand hike, as shown by some analysis in Asia, is not based on recovering demand of consumers or industry, but largely caused by refinery runs that are taking advantage of the relatively low oil prices. Using oil in storage to produce oil products is a normal economic phenomenon, preparing higher-margin products for the future while also opening up some additional storage space for new imports.

Overall, then, optimism should be tempered, as there are not yet any real signs of improvement available in the major economic regions, especially in the U.S. and EU, that would suggest a move towards a pre-coronavirus economy. Oil market analysts and investors seem to forget that current economic figures, which are already extremely bad, are possibly only the tip of the iceberg. When looking at the economic situation in the Eurozone-area, and the EU in general, positive economic figures are largely the result of governmental financial support and will worsen when that support is reduced. Current stimulus packages are not sustainable, and a high level of bankruptcies and lay-offs are to be expected before the end of the summer.

The economic backbone of major industries in Europe, automotive, airlines, tourism, and even manufacturing, is facing a bleak and very insecure couple of years. Demand for crude oil and products will be hit hard if the expected rise in unemployment becomes a reality. The U.S. and other major markets are not looking any better. The current U.S. stimulus packages are propping up some sectors of the economy, while already historically high unemployment figures will lead to foreclosures, higher credit debts, and failed repayments of car loans, etc. Demand for crude oil, in the world’s second-largest consuming market, seems to be heading towards a cliff.

Asian figures, which are being presented by several parties as looking promising, are again unlikely to meet expectations. Chinese production figures and GDP growth were already a subject of much debate before the global pandemic, and now it is going to suffer from lower demand in trade and possible political conflicts. A combination of trade wars, the EU’s reluctancy to keep its doors open to China’s economic might, and a continuing struggle to stave off an internal economic crisis, does not bode well for the Asian giant. Demand for China’s products is down and will continue to decline if its main clients (the E.U. and U.S.) are hit by an economic recession.

Even within the physical oil market itself, it seems that optimism is being misplaced. OPEC+ production cuts are holding, but compliance is at less than 90 percent, which means the main producers are still hitting the markets with additional unwanted oil volumes. Saudi Arabia, UAE, and Kuwait are keeping to their commitments, but Iraq and others are struggling. At the same time, a prolonged production cut strategy is no longer sustainable for several producers as their economies are in shambles, and unrest is brewing. Non-OPEC producers are also looking for a way out, and Russia has indicated that it doesn’t see any long-term options for a production cut. U.S. oil production, which has been hit by both COVID and an OPEC+ oil price war, is currently struggling but has the potential to come back online quickly. If oil prices remain in the $35-40 per barrel range, we will see a re-emergence of several shale oil players and additional (unwanted) volumes in the market. Furthermore, global crude oil storage volumes are still at historically high levels. Last week’s optimistic forecasts of draws of storage volumes is likely a one-off. The fact remains that there is still too much oil available, but SPRs are being used to improve storage figures.

Another reason for our overly optimistic outlook is that the profit strategy of downstream companies has resulted in higher volumes of product in storage, as demand for products is low. This can be seen in U.S. crude stockpiles which were reported to have grown by more than expected, adding to worries about oversupply. American Petroleum Institute (API) reported that U.S. crude inventories rose by 1.7 million barrels last week, well ahead of analysts’ expectations for a 300,000-barrel build. While product volumes showed a storage draw, optimism here is based on the fact that fuel consumption is picking up as some economies ease lockdown measures. When looking at the real figures, demand for products is still way below normal figures for the same time last year. Another major worry is that China, the world’s top crude importer, is also expected to slow crude imports in the third quarter, after record purchases in recent months, as higher oil prices hurt demand and refiners worry about a second virus outbreak.

Looking at fundamentals, combined with increased economic and geopolitical unrest globally, there is no real justification for oil market optimism in 2020. Both the summer and autumn of 2020 will be volatile periods for oil markets, with a possible economic recession of an unknown magnitude hitting the global economy. Optimism should instead be pointed towards 2021. A combination of low investments upstream, combined with potential new unrest in MENA (Libya-Iraq) or removal of the weak parties in upstream, will lead to a supply crisis. Beneath the fog of the current demand discussions and fake optimism about the economic growth of Asia and other regions, there is a supply crisis forming which will hit the market hard. The year 2021 will recharge oil and gas with a bang, as we jump from a demand-driven market to a supply-driven situation. Prices will increase, even with a global economic crisis, but revenues will be distributed to new power players that will replace the current U.S.-E.U. centric oil and gas upstream sector. An average crude oil price (Brent) of above $40 per barrel is wishful thinking in 2020. We may witness hikes, but general fundamentals are showing a $30-$34 range rather than a $40-45.

By Cyril Widdershoven for Oilprice.com