Scraping the Barrel
After a ~65% rally from last week's low, Brent is showing some signs of running out of steam after optimism was driven by investors willing to look through inventory builds because the pace of the accumulation is slowing – potentially a sign that demand has bottomed out – and as markets digest the effect of more countries emerging from lockdown against the backdrop of producers trimming production.
However, in the frame of reference to this week's remarkable rally, sentiment could remain sensitive to bad news, especially as it pertains to Covid-19 and the global macro scrim, hence the propensity to take profits will probably be high. It’s not unusual in the least to see this type of profit-taking proclivity set in when it’s widely perceived markets have moved too far too fast. Hence the aggressive sell-off in crude products post the US Jobless claims and an unexpectedly large build in distillates.
While there are hopes that as economies emerge from lockdowns demand for crude and its derivatives will pick up, there’s still a lot of surplus supply for the markets to chew through. So don’t get your hopes up as crude isn’t going to bounce back to $40/bbl overnight, though the next picture does look less gloomy.
Prices are opening lower in Asia but, so far, the action remains tethered to the psychologically significant Brent $30 per barrel as prices remain supported as the EIA reported the US crude inventories build of 4.6 million barrels (bullish to consensus). Still, an unexpectedly large build in distillate stocks offset a moderate draw in gasoline, which then caused another modest sell-off as oil price remains super sensitive to any negative news. While this may have raised fears of an ongoing surplus, don’t forget that the best cure for low prices is often low prices. US crude oil rig counts have already fallen by more than half since mid/late March.
And, of course, a day would never be complete without President Trump taking shots at China on one level another, which doesn’t provide an optimal platform to stage a lasting recovery in growth assets.
As well as oil prices ripping higher this week, it’s especially worth paying attention to the shape of the curve which suggests the immediate concern over a supply glut has faded. The spread between the 1st and 12th Brent contract has slipped to $6.58/bbl, but up slightly from yesterday’s low. Overall, the contango has flattened significantly from a recent peak of more than $16/bbl and well below the $10/bbl level, which designates issues in seaborne storage.
But with critical market-moving data on the docket this morning in the form China key trade numbers, I’d expect price action to strike a cautionary tone given the sullied price action overnight as markets’ near-term optimistic positioning remain prone to bad news; China consumes about 14m barrels of oil per day and is the biggest importer of crude in the world.
With early signs of recovery in China's domestic travel and zero hedges on their jet fuel consumption, once local and international air travel picks up in June it could provide a significant lift to oil prices also.
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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