Today’s oil price reflects market optimism

Chris Midgley, Global Director of Analytics, S&P Global Platts, sees today’s price reflect optimism in the market, but further upside will most likely be limited due to higher oil stocks and constraints around US supply.

KUWAIT: Ahead of this month’s expiry, WTI has seen a rally as shorts in the market get caught struggling to deliver into the market due to logistics constraints around ability to access pipeline. This contrasts with the experience last month, where participants suffered due to an inability to take physical delivery at land-locked Cushing.

Today’s price reflect optimism in the market, but further upside will most likely be limited due to higher oil stocks and logistics constraints in US supply leading to some discounting.

Supply

Around the world, over $100bn of capex has been cut. In the US, rig count is down by 62 percent and frack crews are down by 85 percent, highlighting much lower activity. OPEC + has plenty of spare capacity to put more oil onto market if prices recover further as they won’t want to stimulate an early US shale rebound. With Oil around $30/bbl, US shale remains under pressure and we expect further bankruptcy filings as smaller companies struggle to service debt.

Demand is partially recovering, as people return to cars, but other areas such as aviation (jet) will see much longer u-shaped recoveries. The likely drag on the global economy will result in 2021 oil demand being 700,000 b/d below 2019 levels, effectively representing a two-year loss of oil demand growth amounting to 3-4 million b/d compared to preCOVID19 forecasts.

Outlook for global oil supply

Global oil supply plunges in 2Q, then OPEC and non-OPEC supply diverges in 2021. OPEC+ market share strategy to weigh on future prices.

Global oil supply revised significantly lower, particularly 2Q, on the back of 9.7 million b/d OPEC+ cut deal and additional non-OPEC supply reductions that will be required. 3.4 million b/d of shut ins announced to date, but more will be required and will need price signals. For 2021, non-OPEC is set to decline while OPEC+ supply improves. In our view, Saudi Arabia and Russia will pursue a market share strategy, putting enough oil in the market to avoid an accelerated increase in price that could overstimulate US shale or other non-OPEC production. We do not believe Saudi.

Outlook for Global Oil Demand

Global economic slump in Q2 continue to be deep. Yet, OECD countries have made progress in mitigating virus spread via lockdowns and are in the process of gradual reopening. Risk of virus spreading in Emerging Markets still present. As a result, the worst year on year drop of demand in April is behind us and the world is embracing a sizable month-on-month recovery in May with an expected growth of over 5 million b/d, led by a “V” shape recovery of gasoline demand.

Demand is now forecast to contract by 8.3 million b/d in 2020 while the aforementioned deep contraction for 2Q is 17.8 million b/d is seen for 2Q though the worst was April with a year on year decline of 22 million b/d.

2021 demand will normalize but stay notably below 2019 levels by some 750,000 b/d, as aviation and global trade struggle.

Asia also been hit hard by the economic slump despite the opportunity to be first in line to recover from the Covid-19 pandemic among all major regions around the world. India in particular saw the worst year on year demand destruction in history last month, bringing down Asia 2Q’s demand down by 4.1 million b/d despite the recovery in a few other Asian countries in May. Demand for the whole year is likely to be 2.5 million b/d below that of 2019.

Outlook for Refining and Product Markets

In just over one week, a steady flow of statements from around the world have taken announced oil supply shut ins from 3.4 to 5 million b/d, topped by the US, Canada, and Kazakhstan. Add to that new reports that indicate Russia is cutting production significantly to comply with OPEC+ cuts and last week’s crucial announcement that Saudi Arabia would cut an additional 1 million b/d in June, and UAE and Kuwait additional volumes, has further solidified the global oil supply response.

In total, explicit announcements on both shut ins and production cuts across non-OPEC and OPEC+ members suggest global oil supply is on course to drop by at least 12-13 million b/d from April levels to June. There is also supply that is coming down without explicit announcements. Plus supply will be on a declining path through 2021/2022 on falling rigs and lower spending.

This puts global oil supply securely on our forecasted path without extraordinary curtailments. They are enough to keep global oil supply within bounds of storage tank tops and balanced with demand that remains weak for May. Combined with stronger physical differentials and lower freight rates, Platts Analytics believes $25-30/b is fair value for Dated Brent for the coming months. We are not overly bullish as much anxiety persists, particularly around demand and the impact of opening up from lockdowns on the infection rate. Later in the Fall, there is the potential impact of a second wave of COVID infections that could reverse oil demand improvements expected in coming months just as bloated stocks start to draw. Nevertheless, the current supply losses, OPEC’s determination, and trend towards opening up point to stronger oil prices than we believed earlier.

Outlook for Oil Prices

Crude prices have improved driven by larger supply cutbacks than initially expected and the prospect for demand recovery as lockdowns ease.

It now seems likely that total oil stocks will stay below capacity limits (just) without additional constraints on production. Platts Analytics sees Dated Brent prices averaging in the $20-30/b range through the summer as stocks will continue to increase in May and then will remain high, keeping the market in contango.

Outlook for NGLs/Petchems

Global NGL supply to by 1.2 million b/d in June 2020 due to OPEC+ cuts, lower refinery runs and shut ins in North America. Res/comm demand and stockpiling appear to be slowing, providing less support for LPG prices. Naphtha production from key Asian countries is expected to be 6.3 million b/d, roughly flat with 2019. Naphtha prices are strengthening as motor gasoline demand slowly returns.

In 2020, ethylene crackers are expected to run at lower utilization rates than we have seen in several years, on the order of 85 percent due to demand loss and new capacity coming online. Aromatics units will also see low utilization rates as gasoline demand slowly returns and new plants start up.

PDH units are those likely to benefit the most during this period of time, as refinery runs are down and FCC units are running in max distillate mode, reducing the supply of refinery grade propylene. We expect utilization rates at PDH plants will be higher than what has been seen in the last several years.