This Week in Oil - June 07, 2020

Second wave...

What’s the most significant news of the week for oil?

If you ask anybody they’ll probably talk to you about OPEC. Indeed this weekend the OPEC decided to extend production cuts for the month of July.

That’s theoretically a production cut of about 10M barrels per day. Of course you have to take into account compliance. The higher the price of oil the harder it is to get proper compliance. So maybe we’ll get something like 8M barrels per day out of circulation until the end of July.

I’m not expecting fireworks but the bulls are surely going to like that. So there really is no reason in the current narrative to see oil prices correcting to the downside in the short term.

As of last Friday we are closing in on $40 for the WTI futures. Already at $35 shale oil is more than happy to restart production. If we reach $45 there is no question we’ll see another shale boom.

Saudi Arabia and Russia know about that. This is why the OPEC+ production cut deal is getting reviewed on a monthly basis. There is a dangerous game played here. Milk the effect of the announcement of production cuts on a monthly basis to keep prices up. But at the same time be ready to scale things down if there are signs that the US production is picking up speed.

There is a sweet spot between market share dominance and price level. Staying at that equilibrium point is probably impossible to achieve though.

For now the EIA data is estimating the US production to be down to 11.2M barrels per day. But there is a large uncertainty on this estimate. Most likely we are sitting at around 10.5M barrels per day and that should be the bottom. 

On the storage side of things this week:

  • US oil draw -2M 

  • Cushing oil draw -2.8M 

  • Gasoline build +2.8M

  • Distillate build +9.9M

And if you take into account the fact that some oil went to the US Strategic Petroleum Reserves there was actually a small build in total US oil stocks this week.

So except for Cushing continuing to draw, it is building everywhere with strong builds on refined products. Is it really what we expect to see with a V-shape recovery of the economy? I don’t know…

The time spreads remain pretty tight, below $0.20, so there is no worries about storage issues at the moment.

Talking about the real economy though things don’t look so good. To keep it simple just have a quick read at the US Congressional Budget Office Interim Projections. These guys are not in the business of spinning negative news. So when you see their projections… damn that’s bad:

  • Real output expected to still be -2% by the end of Q4 2021.

  • Unemployment rate at 10% by the end of Q4 2021 — that’s the rate we had at the top of the 2008 crisis!

  • The impact of the pandemic will lead to a cumulative GDP 5.3% lower by the end of 2030 than projected in January.

Talk to me about a V-shape recovery right? What the Congressional Budget Office sees a very slow recovery of the US economy and an impact on the unemployment level that will take years to resolve.

I understand that right now the focus of the oil market is the balance of supply and demand immediately after the shutdown measures are lifted. The reopening of the economy is what drives the narrative of higher oil prices. But long term things don’t look so good.

And then you think about that for a minute and you realize that none of these projections are trying to quantify what would happen in case the world is hit by a second wave of the COVID19 pandemic…

How likely is that to happen? I think it is much more likely than the market is thinking.

Take the US. Do you see anything in the recent news that could be a catalyst for the start of a second wave? I’ll give you one second to think… Ok. How about the massive protests/riots going in so many big cities at the moment?

You have people packed together. No social distancing. Wearing mask is optional and not very useful when you are coughing your lungs out after inhaling tear gas. Same thing on the side of the law enforcement units. This is a breeding ground for contagion.

If the protests die down in a few weeks, what will remain is the source of a second wave of coronavirus. I let you imagine the consequences of a second lockdown…

I think the oil market is not taking that into account at the moment. We are already overdue for a correction in this rally and we might end up getting a big one!

The things to watch for next week:

  • How is the market reacting to the extension of the OPEC cuts.

  • How the protests are evolving in the US.

  • Which countries start implementing lockdown to protect against a second wave of coronavirus.

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