Scraping the Barrel
Oil surged to its highest level since mid-March on Friday and leaped higher in early Asia trading. It seems many were caught flatfooted by the quicker pace of rebalancing, forcing speculators to play catchup with price discovery that’s been pointing to a favorable trend for the past two weeks.
Oil demand is recovering in a V shape fashion as massive oil-importing economies carry on with restarting activity, and as OPEC+ and G-20 producers show an unparalleled commitment to supply discipline.
The balance of risk has tilted to the upside. Oil prices may show further upside momentum, especially as the easing in mobility restrictions grows. Indeed, the market is knocking at the WTI $30 door, which will be a significant psychological inflection point if traders put some decent headroom above that fundamental level.
The nascent phase of the recovery may soon be complemented by a relaxation in travel restrictions and a lifting of all limitations on internal movement, meaning people could drive further than around the block and eventually fly, which should lead to a pick-up in the extremely depressed aviation fuel sector. Italy plans to reopen its international boarder from June 3 and lift all restrictions on internal movement to help boost summer tourism. So, by the end of June, if the Covid-19 curve remains flat, we could see travel restrictions removed globally.
EIA inventory data largely confirms an improving trend in US fundamental data, while Apple Maps’ driving behavior data shows US driving is nearly back to pre-Covid-19 levels and shows a positive divergence over public transport use. So, demand is recovering at a much quicker pace than expected. At the same time, US shale supply responsiveness to the fall in prices has seen domestic production decline ten times faster than in the 2015-16 episode.
The stronger-than-expected OPEC+ commitment to supply discipline with OPEC sticking to May/June cuts for H2-20 and a continued demand improvement could translate into deficits sooner than expected.
The drop in inventory levels has been more the result of a fundamental rebalancing than disruptive front-end pricing, which is a hugely bullish signal. And with simultaneous declines in both the national and Cushing inventories, it suggests there’s no diverting of crude from Cushing into other storage facilities.
Besides the usual inventory data this week, traders will be keenly focused on refinery runs to see if the map to recovery is already being seen in product demand. The fact that refinery runs are still near the lows may be a function of the inventory overhang, which will need to be consumed before traders will feel confident to take the next leg higher.
In general, storage overhang will be the next hurdle for the bulls to navigate, especially given "An armada of tankers filled with Saudi Arabian crude steaming toward the US threatens to prevent America's oil glut from draining, which is only just beginning", according to Bloomberg. This is probably in the price as the oil community uses tanker tracking data in its quant analysis, and it’s also unlikely the tankers will offload en-masse.
Still, risk assets are getting held back as investors continue to peer over their shoulders at the escalating tensions between the US and China. At the same time, Australia's trade minister has noted that requests to discuss trade issues with China have gone unanswered. At some point, this political imbroglio is bound to hurt sentiment in the oil markets.
Open interest in June has dwindled to around 75K and volumes are way down; low liquidity rather than storage capacity could be more of a bother than anything else.
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Stocks soar, powered by first-rate earnings and a dazzling run of economic data; Gold plays catch as G10 falls flat while oil basks in the afterglow