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Oil at Fresh highs as demand-side brightens

The oil markets have been seeing the light as of late. Oil prices have reached an eight-month high, with WTI and Brent Crude trading around $45 and $48. This is from the recent positive vaccine news, alongside better than expected EIA data and geopolitical supply-side tensions.

Brent Crude eyeing out $50 a barrel

Oil supply and demand fundamentals are getting brighter

Peter McNally, global head of industrials, materials, and energy at Third Bridge, stated that "it has been a really good run. We haven't seen a run like this since the spring after we went to negative prices." He also stated that "Sentiment has changed pretty quickly… lately it feels like supply and demand fundamentals are heading in the right direction."

Many markets have been revolving around optimism on a vaccine, and Oil is no exception. The Price of Oil has come a long way, from the price war between Saudi and Russia earlier this year, alongside Oil going negative in late April. With the vaccine in sight, the Oil markets are banking on increasing demand in the following months. Bloomberg also reported that Chinese and Indian refiners had issued a large number of tenders seeking crude Oil for loading in Jan, highlighting the strong demand from parts in Asia.

The supply side is also providing pressure for Oil upwards, with the geopolitical tensions rising with recent attacks on a fuel depot in Saudi and an oil tanker in the Red Sea.

Oil rally also causing problems for OPEC

Iraq's fiscal breakeven price for oil

However, the main governing body for the oil markets, OPEC, is having some troubles with their members. Iraq, which requires an oil fiscal break-even price of $64, is voicing their frustrations at OPEC's "one size fits all" policy. Iraq's Finance and Deputy Prime Minister, Ali Alawi, stated that "We have reached the limit of our ability and willingness to accept a policy of one size fits all."

Although they have breached OPEC's quotas many times this year, Iraq is quite influential within OPEC, as they are the largest producer after Saudi Arabia. OPEC is set to renew its policies regarding supply cuts on December 1st.

OPEC is placed in an awkward position, as rising oil prices means it's harder to come to a consensus for the 13 countries on whether they should continue to cut supply to the market, in turn, giving up the opportunity to lock in revenue for years to come.

Oil falls on stalling recovery

The largest oil consumers are both the United States and European Union – making up around 34% of the worldwide 100 Million demand (before the Coronavirus). Both Countries / Continents have seen daily increases in their Coronavirus case count. The United States currently has 7.1m Coronavirus cases, while Europe has around 5 million cases. Coincidentally (or not) – this makes up 36% of the total global Coronavirus cases. In other words, the future of the price of oil is heavily influenced by how these two nations handle the Coronavirus. Europe has to deal with individual countries governed by different styles of government to manage the Coronavirus. The United States, unfortunately, has all but given up.

Brent Crude drops 4%

Brent Crude fell as much as 4% as Global risk-on sentiment softens. A resurgence in Coronavirus cases in Europe, alongside a constant double-digit reporting of new cases in the United States, pushed oil down. Oil's struggle to rally comes from weak global fundamentals; therefore, it is quite susceptible to pullbacks. Brent has been trading in a tight range from $40 - $45 a barrel for the past couple of months.

Oil countries struggling

Low oil prices have forced many oil-producing countries to draw into their pockets to continue supporting their country. Most notably, with the lowest production cost of any oil producer at $2.80 per barrel, Saudi Arabia requires oil prices to be at $76 a barrel to achieve a fiscal break even. This has forced Saudi Arabia to triple its value-added tax, cut spending, and suspend the living allowance cost.

Oil trading houses going green

However, the long-term oil trend may not be as bright as OPEC+ may want it to be. Oil trading houses such as Mercuria, Vitol, Trafigura, and Gunvor are investing billions of dollars into renewable energy projects in the coming five years. Marco Dunand, Chief Executive of Mercuria, told the Financial Times that "If you want to exist in 10 years' time and don't want to be in renewables then I think it's going to be tough" and that "Ove the next five years we should have about 50% of our investments into renewables".  However, oil giant BP predicts that developing countries will continue driving oil growth over the next ten years.

What's your viewpoint on oil?

Could we see a full oil recovery this year?

Some quick numbers – Globally, there are over 15 Million Coronavirus cases and 618,000 deaths due to the pandemic. An estimated 47 million people may lose their jobs in the United States alone. Oil dived into negative, an unprecedented move. However, the NASDAQ is having its best year having made a V shape recovery, Elon Musk is the 13th Richest person in the world surpassing Warren Buffet, and masks are all the rage.

Oil markets not joining in the Euphoria

However, this optimism hasn’t translated into the oil markets. Although we’ve seen a double in price from its March lows, March lows were around $16-$20 a barrel, which is fiscally and financially unsustainable for all oil-producing companies. This V-shape recovery in equities was caused by investors and traders baking in potential future earnings and using it to value the stock price now. The main problem is that there is no set rule as to how far ahead in the future investors and traders should look forward – enabling essentially an “oh, they’ll be fine after the Coronavirus” mentality. Oil does not have this luxury. Oil needs to be delivered every month. This means speculators and traders (in the physical market) can’t wait for future results.

If the equity markets look into the future, the spot market looks at the now. With Gold, a safe haven asset reaching all-time highs and Oil struggling to get back past its boom days, both commodities recognize the current risks the world faces due to the Coronavirus.

We can see that in the United States, the recovery in oil is stalling due to a second wave of the Coronavirus, forcing people to travel less and stay at home more. Cushing Crude oil stocks are not coming down from their all-time highs, and Petrol demand is down 100,000 barrels per day (b/d). We may see a spread between the US benchmark WTI and Brent Crude, the global benchmark as travel around the world picks up relative to the United States.

US Crude oil stockpiles

Long term trends may see the demise of Oil

However, long term trends with government stimulus for greener alternatives to fossil fuels may prevent oil from ever getting back to its hay days. With Joe Biden putting clean energy at the forefront of his $2 Trillion campaign and the EU 750 Billion Euro recovery fund pledging 1/3 of the fund to fight climate change, oil sees pressure downwards both from the demand and supply side.

The fundamental issue with oil is the opportunity cost dynamic relative to other energy sources. With oil prices quite low, renewable resources are expensive in comparison to oil. However, with billions of government stimulus, alongside the supply of oil slowly drying up, exploration for new oil reserves would yield a lower return, increasing the opportunity cost and oil price. While a restriction in supply and an increase in price would be good for oil producers in the short term, with everything else equal, a shift to renewable energy will ensue. Energy Strategist at think-tank Carbon Tracker, Kingsmill Bond, stated that “the world has 50 years of proven oil reserves.” Furthermore, he stated, "the prospect of declining demand as a result of electric vehicle adoption and policy changes means we no longer need a huge oil exploration industry tooled up forever-rising consumption – the talent and resources of the industry can be deployed elsewhere.”

Some oil giants are not scared of a boom in renewables

However, this has not stopped some producers from making big bets. Chevron acquired Noble energy in an all-stock deal for $13 Billion in amidst of bankruptcies in the oil industry due to the Coronavirus.

For now, the Coronavirus is controlling the oil markets. However, we may see a slow shift out of fossil fuels as time goes along,

Oil markets may stay imbalanced

Oil markets may stay imbalanced – even after the Coronavirus passes. The oil markets have suffered dramatically as lockdowns destroy demand for the black gold. In their latest monthly oil report, OPEC predicts a 9.1 million barrels per day (mbd) demand contraction in 2020, to 90.59 mbd. This is on the back of OPEC and non-OPEC participants agreeing to unprecedented supply cuts, currently totaling 14.48 mbd.

Oil markets can't just stop supplying oil

However, suppliers can't just "stop supplying" oil, nor are they incentivized too. Closing off oil wells may cause irreversible damage or worse, making the reservoir basically useless. "The longer a reservoir remains out of operation, the higher the chance that changes in pressure, water content, and residue clogging will affect future output," said Vitaly Yermakov to Bloomberg, a senior research fellow at the Oxford Institute for Energy Studies. Suffice to say, it takes time and money to restrict supply; therefore, suppliers really, really do not want to do so. Nevertheless, the de-facto leader of OPEC, Saudi Arabia, seems to be keeping up their end of the bargain and more. Saudi Announced a further 1m/bd cut on top of their 3.8 mbd cut in April.

That was a long-wounded way of saying it takes some time for oil suppliers to cut supply; therefore, it has not been able to react to the sudden demand shock that the oil markets have experienced. This has caused a massive imbalance of supply and demand, causing significant concerns with regards to storage capacity. This was part of the reason as to why WTI futures expiring in April went into negative for the first time.

Demand is slowly coming back

There is tentative evidence, however, that this storage is easing up. The EIA release data showing US stockpiles unexpectedly dropping by 0.745 million barrels, compared to forecasts of a 4.146 million rise. Similarly, to how it took time for supply to react to demand, it may take time for procurement to pick up as demand picks up again.

With the EIA predicting demand to outpace supply by Q3 2020, an imbalance in order is predicted to outpace supply. Since oil is a spot asset alongside the fact that the short to medium turn effects due to the Coronavirus is extremely difficult to forecast, traders have been cautious about going long on the commodity. That does not mean speculators have taken advantage of the low prices. OPEC stated that "despite a significant decline in oil prices, hedge funds and other money managers firmly raised their combined futures and options net long positions" with "speculators inreasing their net long positions in WTI to reach their highest level since January this year."

Imbalance may turn into Oil Markets favour

However, this imbalance may soon shift in the oil producers' favor. Forecasts from the EIA and OPEC with regards to oil demand remain relatively prudent, with one crucial underlying assumption: consumers of oil do not change their behavior. Demand for Jet fuel may be down, but that only represents 8% of the daily global demand for oil pre Coronavirus levels. This is in comparison to gasoline, which makes up 23% of the daily global demand. Predictions of expensive overseas business trips being replaced with free Zoom video calls may be getting traction. Still, there is a high likelihood that demand for gasoline will increase for one specific reason: people fear they will contract the Coronavirus while they are on public transport.

Quick maths

Let's do some quick back of the envelope (and frankly, quite rudimentary and crude) math's here. I'm from Auckland, New Zealand, so I will use us as an example. There were over 22 Million passengers who took the Auckland Transport Metro train service in 2019. On Average, that is 60,274 passengers per day. Over 77% of New Zealanders are over 18, therefore can have a drivers licence - (My brother is over 18, and he does not have his drivers licence) so for prudence sake ill say 60% of New Zealanders have their drivers licence. Lets assume then, 60% of the average daily passengers can drive. That leaves us with 36,164 passengers. There are over 3.5 million registered cars in New Zealand. This means with a population of around 4.9 million, there are over 0.7 cars per person in New Zealand. If we then apply this is 36,164 passengers figure we got, we get about 25,315 individuals with a vehicle – which is around 0.04% of New Zealand's population. If we scale that up to the world's population, that approximately 31.2 million people in the world that take the train, that has the opportunity to drive instead of taking the train.

Phew. Okay. So, the average car takes around 0.35 barrels of fuel. Therefore if 31.2 Million people globally drive, instead of taking the train - this would equate to approximately 11 Million Barrels of extra oil demand.

People don't want to take public transport

Sure, the maths is quite arbitrary – however, this does not consider other forms of public transport, such as the ferry or bus. James Li, a public relations account director told Bloomberg that he would rather sit an hour in Beijing traffic than 30 minutes exposed to crowds on a train. Patrick Pouyanne, CEO of French oil giant Total SA also told Bloomberg that "People are using more of their cars because they are afraid to use public transport." Tentative signs for this are showing Apple Maps data for 27 world cities showing that more people are driving cars than taking public transport as lockdowns ease. Furthermore, with places such as New Zealand closing their borders off and airlines operating at 60% capacity to adhere to social distancing rules, domestic road trips may be the only alternative for people who do not want to pay the high price of domestic air travel.

It is yet to be seen whether oil will bounce back to fiscal break-even levels for oil-producing countries. But this potential catalyst for an increase in gasoline may help the oil markets grind back to its formal glory.

Anish Lal, an analyst here at Blackbull Markets has an excellent video about the reasons to be bullish on gold. You can watch the video here.

Oil futures lower on concerns over capacity and negative prices

It has been a bloody couple of weeks for the oil markets. A price war between Saudi and Russia, a depression in demand due to the coronavirus and a slow reaction from oil producers in cutting supply, has crushed the price of oil. Add to that a sprinkle of fundamental supply and demand forces hitting the futures market for oil, and you get the unprecedented price of -$37.63 for a barrel of WTI.

Futures were down today to a low of $10.07 and $19.99 for WTI and Brent, respectively. Concerns over negative prices repeating the next month loom for WTI as we edge closer to the expiry date for July, with the spread between WTI and Brent edging higher. But it is not all good news for Brent. With inventories across the world increasing, filling up excess capacity, negative prices for Brent are not out of the question. However, the odds are stacked up against WTI – with futures being physically settled in Cushing, Oklahoma, and storage being primarily onshore. This is in comparison to Brent with futures being settled in cash alongside the mobility being able to be stored on carrier vessels offshore.

Energy Aspects Chief Oil Analyst Amrita Sen told Bloomberg that the supply recovery is likely to lag the rise in demand for oil, giving a glimmer of hope for the battered commodity. Furthermore, Major OPEC countries Saudi Arabia, Kuwait, Algeria, and Nigeria have already started cutting supply ahead of agreed May 1st start date for the historical deal for where OPEC countries would collectively cut around 10% of the supply of oil to combat the effects of the coronavirus on the price of oil. With countries slowly getting out of lockdown, the demand for refined oil products is predicted to creep up in the following months. Nevertheless, significant countries such as the United States are still getting hammered by the effects of the coronavirus, which may stagger that increase in demand for refined oil products across the world.

This uncertainty with supply and demand, alongside capacity concerns and a repeat the negative prices last month, is being reflected in the drop in price today. But the fact that the price is not negative today may be considered as a good sign as it can be interpreted as traders selling their positions now so they do not experience what happened last week with oil, relieving the selling pressure come expiry for the June oil contracts for WTI.

Oil Traders need to be prepared for volatile and violent swings as supply and demand forces clash it out in the next couple of weeks.