Crude already reflects market's view that rebalancing is still some time away

Crude prices lost more than 4 percent as the passing of Hurricane Laura brought the focus back on uncertain demand outlook amid the coronavirus pandemic. The demand rebound is also sputtering. Prices got dented by lower refinery runs and the upcoming maintenance season that is expected to dent demand for crude.

In recent weeks, the contango has deepened to more than $2 a barrel between November 2020 and May 2021 compared to $0.48 a barrel in the middle of June.

Also, the WTI forward curve weakened this week. WTI’s near-term contract is at the biggest discount to its second month contract since June. This shows that oversupply fears are still there in the market.

Supply

EIA reported a crude oil inventory draw of 9.4MB drive by Hurricane Laura. Gasoline demand had recovered to 90 percent of last year’s demand by the end of June. However, consumption has been hovering around those levels in July and August, suggesting that demand is struggling to return to pre-pandemic levels.

Middle distillates inventories at Asia's oil hub of Singapore have soared above a nine-year high, which is still a major concern for markets.
While inventories saw a drawdown in recent weeks, including the US, demand is struggling to recover as much as estimations two months ago.

Friday data from Baker Hughes, meanwhile, showed that the number of active US rigs drilling for oil rose by 1 to 181 this week, following a decline of three rigs the previous week.

It seems that despite significant pressure, Iraq is simply unable to comply with its quota restrictions and will continue to be a major issue for OPEC when the group’s technical committee meets in September.

The OPEC club of oil-exporters has revived crude from its historic drop this year but $40 is still too low. The Covid-19 pandemic and shift toward renewable energy threaten to keep prices depressed.

Demand outlook

The US jet fuel consumption has been particularly affected by responses to Covid-19. However, analysis of flight data estimates suggests that demand for jet fuel in the United States has, so far, recovered faster than in many other major aviation markets.

EIA estimates that as of August 16, 2020, consumption of jet fuel by US commercial passenger flights was approximately 612,000 Bpd, 43 percent of the estimated amount consumed on the same date one year earlier.

Still, a number of factors are now testing prices, including the approaching decline in China's crude imports in September and October, which are set to fall for the first time in five months as oil buyers struggle to find room to store record volumes of crude.

Chinese refiners have reduced their runs, while floating storage remains around 80MB. The sudden weakening of China oil imports will adversely affect purchasing for October-loading barrels and will leave some spot barrels still available and unsold in the market.

Outlook

Crude market already reflects the market's view that rebalancing is still some time away. The contango market structure signals concerns about oversupply and describes a situation where the price of oil for future delivery is lower than for the current month.

Russia's statement asking OPEC+ to react to oil demand recovery by increasing supply signals that Russian President Vladimir Putin might push for the group to increase production as early as JPMC meet scheduled for September 17.

Given the ongoing weakness in indicators in the US, which is the world's largest oil consumer, plans to increase production could crater oil prices if OPEC+ isn’t careful.

(The author is VP – Commodities Research at Motilal Oswal Financial Services.)

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