Scraping the Barrel
Crude oil has resumed its recovery with prices back to levels not seen since early April. This comes after a crude draw reported in the EIA inventory stats, complemented by declines in Cushing. The simultaneous decreases in both the national and Cushing inventory suggest there’s no diverting of crude from Cushing into other storage facilities. The drop in inventory levels has been more the result of a fundamental rebalancing than disruptive front-end pricing.
The problematic scenario of full storage has been avoided due to the significantly faster-than-expected fall in US production, which itself is a function of slashed spending but also economic curtailments. The massive 'adjustment factor' in the latest EIA reconciliations of inventory, supply and demand is testimony to this and sends a critical signal to investors that troublesome concerns over mechanics of oil delivery are much less of a concern.
Thus far, traders were right to call a trough in global demand in April. Still, oil prices will remain sensitive to any hint that the easing of global lockdowns might result in the second wave of Covid-19 infections and, therefore, a more protracted impact on demand.
Oil has moved quickly to the reopening news flows, and while this seems mostly justified, it would be wise to pay close attention to the risks in what remains uncertain. The uncertainties on the supply side are less noticeable. With WTI approaching the $35/b level, it will be essential to see US shale producers exercising supply discipline that has helped accelerate the rebalancing of supply and demand. Any sign of a rapid rebound in US production as oil prices recover would derail the recovery.
The risk, therefore, as markets get turns more bullishly constructive and prices rise, is that some of these economic curtailments return to the market, but no-one is entirely sure at what price level this happens. But it’ll most likely start to factor into sentiment as cross-asset traders grow increasingly concerned with the time mismatch between the market's pricing structure and how the real economy performs. The main obstacle in the bullish oil market view might be the weak labor markets that could delay an all systems go lift-off after lockdown. It’s one thing getting factories up and running, it’s quite another getting consumer demand going when folks are worried about their jobs
While the substantial decline in stockpiles at Cushing, the delivery point for WTI futures, indicates the supply glut is starting to ease, the bearish to consensus increase in US gasoline inventories, which caused the July NYMEX to tumble, was the only major hiccup in the week as oil notched its most protracted streak of gains in more than a year.
The weekly US inventory data released this week by the EIA supports a relatively optimistic view of supply/demand fundamentals for oil, with a big 5mb crude draw (in line with the 4.8mb draw reported on Tuesday by the API) and an uptick in refinery utilization offsetting evidence of a small drop in product demand. Traders looked through the gasoline inventory spike in favor of the Cushing inventory falls as more parts of the US economy are reopening and presumably more people are driving.
The EIA Drilling Productivity Report, which was released earlier this week, provided some basis for optimism, with an 805kb/d decline in production in the DPR regions now forecast for May. US production has fallen much more rapidly than expected, likely a function of voluntary curtailments by producers choosing to hold back for a better price environment and involuntary shut-ins due to low oil prices.
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US equities continue to welcome any high-risk event being put in the rear-view mirror – especially when rates markets look prime to consolidate lower