NBK Economic Report

Oil prices remain range-bound in July as virus clouds outlook

KUWAIT: Oil prices have been range-bound for most of the last month, trading in the low $40s and inching up only in the last week to four-month highs of $44.32/bbl for the international benchmark Brent crude and $41.96/bbl for the US marker West Texas Intermediate (WTI). Gains stemming from a visibly tightening physical market have largely been kept in check by worries over prolonged oil demand weakness due to resurgent Covid-19 infections in the US and elsewhere.

As proxies for oil demand, the weekly movements in US crude and product stocks and, to a lesser extent, refinery processing rates, have been the primary barometers of market sentiment and the triggers for movements in oil prices. This has been more pronounced since supply-side fundamentals are roughly pointing in the right direction thanks to the supplytightening efforts of OPEC+.

Fiscal and monetary stimulus to mitigate the negative effects of the pandemic have also been significant price influencers. News of the European Union’s EUR750 billion recovery fund propelled Brent crude to its fourmonth high last Tuesday. News on anti-COVID drugs and vaccine development has a powerful effect on the oil and broader financial markets.

Nevertheless, it has been the OPEC+ oil supply cuts and those involuntary supply curtailments in the US shale patch and Canadian tar sands developments that have really underpinned price gains since the end of April; a third consecutive month of price rises looks on the cards in July, with Brent up almost 6 percent this month (though still down more than 34 percent in 2020). The decision by the OPEC+ group after the recent JMMC meeting to begin tapering its 9.7 mb/d worth of production cuts and start pumping again in August for the first time since April had negligible impact on the markets, much of it having already been priced in thanks to careful signposting by the producer group. Moreover, expected additional volumes in August will be about half as much as initially scheduled, since producers such as Iraq, Nigeria and Angola will have to continue to make deeper cuts to compensate for not meeting their targets in May, June and perhaps even July.

Kuwait Export Crude (KEC), has risen by a sizeable 19.5 percent this month; after months of heavy discounts, the medium sour blend finally caught up to the price levels of competitor crude grades of similar quality. KEC jumped above $40 on 1 July and was as high as $44.8/bbl last Thursday before slipping a little to $43.4/bbl on Friday.

Indeed, medium crudes such as KEC, Saudi Arab Medium and Basra Light, which traditionally sell at a discount compared to lighter crudes that yield more gasoline, diesel and jet fuel per barrel, have had a good run in recent months, commanding higher than usual prices as a result of weak demand (and therefore refining margins) for diesel and jet fuel due to the coronavirus pandemic.

Oil demand outlook

The spike in coronavirus infections in economies newly emerging from weeks of lockdown has, however, been troubling, especially in the US. Some restrictions on mobility have had to be reimposed. Coming in the midst of the peak summer driving season, when gasoline usage usually rises, the persistence of the pandemic is bound to add to US oil demand woes especially. The threat of prolonged oil demand weakness was a major caveat in the International Energy Agency’s (IEA) upwardly revised oil demand forecast for 2020. The agency, in its July oil market report, noted that its 360 kb/d upward revision to oil demand growth (vs. June estimate) in 2020 is contingent on the pandemic being brought under control. This would bring the year average contraction in global oil demand to 7.9 mb/d rather than 8.1 mb/d as forecast earlier. The estimate of the year-on-year decline in 2Q20 is an eye-watering 16.4 mb/d. These are unprecedented figures for demand destruction, and with the pandemic raging in large parts of the southern hemisphere and persisting in heavy oil consuming economies in the northern hemisphere, downside risks to the oil demand outlook are sizeable.

For the time being, oil consumption is accelerating in countries emerging from lockdown. In the far east, in Europe and in the middle east, where summer temperatures typically drive increased domestic demand for power generation (cooling etc.) Indeed, Saudi energy minister Prince Abdlulaziz pointed to such seasonal oil demand effects being even more ‘pronounced’ this year as GCC populations stay indoors amid continued travel restrictions. The Prince assured market watchers fearful of a deluge of new Saudi supply that “not a single additional barrel will be exported”. Russian energy minister Novak echoed the Prince’s remarks, saying that he believed that most of the additional oil be consumed by domestic market rather than exported.

The improvement in oil demand has been most noticeable in China. Figures from the country’s National Bureau of Statistics showed that crude refinery throughputs hit an all-time high of 14.14 mb/d in June, rising 9 percent y/y on the back of record-high crude import volumes (13 mb/d in June, according to General Administration of Customs data), much of which is admittedly opportunistic buying as China capitalizes on low oil prices. In India, petroleum product consumption is recovering from its 13-year low in April (9.9 million tons), with fuel demand reaching over 92 percent of pre-COVID levels in June, the Ministry of Petroleum and Natural Gas reported. This has been led by gasoline and diesel demand, as commuters prioritize private over public transportation-a recurring theme of the postlockdown global landscape. In contrast, aviation fuel demand remains considerably weak.

OPEC+ to taper supply cuts

OPEC-13 crude production fell to a three-decade low of 24.3 mb/d in June as producers, led by Saudi Arabia, slashed output to bring supply and demand closer to balance. OPEC-10 recorded compliance of 110 percent in June (Libya, Iran and Venezuela are exempt from production quotas). After including the 10-non-OPEC members led by Russia, aggregate compliance reached 106 percent in June, up from 85 percent in May.

The OPEC+ group therefore delivered around 10.3 mb/d of output cuts (or more than 10 percent of prepandemic global oil supply), exceeding their target of 9.7 mb/d, according to non-OPEC figures assessed by Platts. At July’s Joint Ministerial Monitoring Committee meeting (JMMC), the group agreed to begin winding down these cuts, to 7.7 mb/d for the period of August to end-December.

In practice, however, only about half of the 2 mb/d of additional supply is expected in August, since non-compliant producers, such as Iraq, Nigeria and Angola, have promised to continue with deeper cuts to compensate other members for the months in which they failed to cut output to the required level.

Tighter supplies should see global inventories draw down in 2H20

According to our estimates, which draw on IEA demand and non-OPEC supply projections, global stocks should begin to decline from this quarter onwards-by 4.8 mb/d in 3Q20 and 6.2 mb/d in 4Q20 on average-having ballooned in 2Q20 (+9.3 mb/d) on the back of rampant oversupply and dramatic demand destruction. (See chart 2.) This should help OPEC+ achieve its key target of returning global inventories back to their five-year average. The IEA estimated that global (OECD) inventories stood at 3.22 billion barrels in May, 258.5 million barrels above the five-year average, the most recent month for which there is data.

The outlook, of course, is dependent on continued OPEC+ compliance and oil demand growth recovering in tandem with consumer and industrial activity. A persisting pandemic and/or a second flare up of infections in the autumn/winter represents a major downside risk factor for oil prices. News that a University of Oxford Covid-19 vaccine has shown promise and moved into phase three clinical trials would be just the right medicine for the oil market as well.