Despite the recommendation of the OPEC+ JMMC to ease the oil output cuts by 2 million bbl/d, oil markets maintained their bullish sentiment over the past week as Brent was trading above $43 while WTI was trading above $40. A surge in COVID-19 cases in several counties including the US, Spain, and Australia capped oil price gains.
Bullish figures from the EIA
Markets were primarily supported by a continued withdrawal in commercial crude inventories which declined by 7.5 million barrels w/w to stand at 531.7 million barrels. Gasoline inventories also declined by 3.1 million barrels w/w reflecting a significant rise in demand levels. Along the decline in inventories, crude imports fell by 1.83 million bbl/d w/w and are currently standing at 5.57 million bbl/d, which may be part of the reason for the drop in inventories. The other reason for the decline in inventories is the balance in the markets where demand now exceeds supply, something we had anticipated, last April, to take place in July.
We currently expect commercial inventories to continue to decline especially during July and August as these months historically are the peak of driving season. U.S. oil production continues to be fixed at 11 million bbl/d for the 3rd consecutive week. The decline in oil rigs continues, with the latest figure being 1 rig w/w, and it may have already reached its lowest level at around 180 rigs.
Demand figures continue to be revised up
Similar to the IEA and EIA, OPEC raised its 2020 demand forecast to 90.72 million bbl/d, up by 0.13 million bbl/d from its previous forecast, which is 0.375 million bbl/d higher than CMarkits’ forecast. This includes an expected average demand of 92.22 million bbl/d and 96.22 million bbl/d in Q3 and Q4 2020, respectively. This is higher than CMarkits’ forecast by 0.11 million bbl/d and 1.89 million bbl/d, respectively. Furthermore, non-OPEC supply is expected to stand at 61.76 million bbl/d in 2020, down by 3.26 million bbl/d w/w, which is 0.99 million bbl/d higher than CMarkits’ forecast. The majority of production decline will come from the US and FSU due to forced shut-ins and participation in the OPEC+ output cuts. Furthermore, the OPEC-10 countries have collectively achieved a total compliance of 103.64% in June, despite many countries falling behind their targets including Angola, Congo, Equatorial Guinea, Gabon, Iraq, and Nigeria. The total OPEC+ compliance was reported to stand at 107% supported by voluntary contributions from Saudi Arabia, UAE and Kuwait.
OPEC+ additional production will be offset by deeper cuts
Meanwhile, OPEC+ JMMC has recommended transitioning into the 2nd phase of the cut agreement which is set to ease output cuts by 2 million bbl/d starting from August. Yet the impact of this decision was little felt on the markets last week, for three reasons (i) demand is still expected to be higher than supply in Q3 and Q4, and (ii) deeper cuts from low-compliance countries will amount to at least 0.8 million bbl/d in Q3, and (iii) the increase in production will not lead to an increase in exports. The Nigerian Energy Minister has confirmed that his country would commit to achieving a 100% compliance by the end of July including deeper compensatory cuts, and this will continue till the end of Q3.
It is expected that the August production figures will include the 7.68 million bbl/d cuts plus at least extra 0.4 million bbl/d of compensatory cuts from previously non-complying countries leading to effective cuts of at least 8.1 million bbl/d. Still some countries are yet to submit their compensation plans by the end of July. Saudi Arabia and Russia will equally be ramping up their individual production by around 0.5 million bbl/d which will go to national consumption of gasoline and diesel as the two countries re-open their economies. This was confirmed by both the Saudi and the Russian Energy ministers. According to our forecast, Q3 demand figures are expected to stand at 3.69 million bbl/d and 4.40 million bbl/d for Saudi Arabia and Russia, respectively.
Although OPEC+ may celebrate the first phase of the achievement, it remains cautious with easing its cuts through the 2nd half of the year. Fears of a 2nd wave of COVID-19 in many countries around the world continues to have an impact on the markets. Saudi Arabia’s Energy Minister has emphasized that the group is open to revise its decision if the market situation changes, particularly referring to demand shocks similar to those in April.
Despite the relaxation of OPEC+ cuts, crude continued to trade within the $40-43 range. Yet, Saudi Arabia’s Energy Minister, Prince Abdulaziz bin Salman, had highlighted that although OPEC itself does not have a price target, current prices are not sustainable for the industry, leading to potential insecurity of supply in the long term.
CMarkits’ latest forecast sees an average price of $43 for Brent in July that may rise to $50 by December if demand continues to smoothly recover. Morgan Stanley had also raised its forecast for Brent by $5 to $40 in Q3, something we had predicted at the beginning of Q2.
Another bullish indicator for crude is the development of a vaccine against COVID-19. Oxford University announced last week that a potential vaccine may be introduced by September which could have a dramatic impact on the global economy.
While OPEC+ has noted improving compliance levels and market conditions, we believe that the remaining challenge is not only the price, but most importantly the continued drawdown of oil inventories, which remain near historic highs. Bringing inventory levels back to pre-crisis levels, which we do not expect to be reached until mid 2021, is a major goal for OPEC as highlighted by Prince Abdulaziz. The Saudi Oil Minister also stated that the agreement is biblical in a way and that it cannot be changed even if the demand picture comes up better than what was expected in 2021 and 2022. Even if the agreement ends in 2022, an equivalent agreement should make sure the crude market remains balanced.
The next JMMC meeting will be held virtually on August 18th which is expected to review July production figures, compliance rates while verifying compensation plans of countries that didn’t reach 100% compliance.
By Yousef Alshammari by Oilprice.com