Have Oil Traders Abandoned Fundamentals?

By Nick Cunningham

Oil prices are back at levels last seen in mid-March, and while fundamentals for crude have improved somewhat, markets have become too optimistic

Market euphoria continues to push financial markets and commodities higher, and oil prices have climbed back to levels not seen since lockdown orders in the U.S. began in March.

By a variety of metrics, markets have recently made up a lot of lost ground over the past two and a half months. The Dow Jones Industrial Average surged past 25,000 points on Tuesday, and the S&P 500 jumped above 3,000. Both thresholds were last reached in March.

WTI rose above $34 per barrel on Tuesday, another two-and-a-half month high. “For Economy, Worst of Coronavirus Shutdowns May Be Over,” a Wall Street Journal headline blared, citing an array of hopeful statistics on hotel spending, restaurant bookings and airline traffic.

But the gap between the stock market and the real economy continues to widen. Over 38 million people have filed for unemployment. Corporate bankruptcies have begun to accelerate, even as the worst lies ahead. A real estate crisis is brewing in both corporate and residential sectors, with millions of people and thousands of businesses unable to pay rent and mortgages.

In the oil market, improving sentiment has at least some basis in fundamentals. Rystad Energy estimates that the oil market was oversupplied by around 16 million barrels per day (mb/d) in April, a massive overhang that forced prices into negative territory. The rapid shut in of around 12 mb/d (largely shouldered by OPEC+) has erased a huge portion of the surplus. The widely-publicized rebound in demand – of around 4 mb/d, according to Rystad – puts the market close to “balanced” in June.

However, again, there is a disconnect between sentiment and the current state of the market. Oil prices are back at levels last seen in mid-March, prior to the shutdown of the economy. “We find it hard to justify why prices are where they were on 11 March,” Standard Chartered wrote in a note on Tuesday. “We do not think expectations about the future have brightened significantly since this date.”

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The investment bank noted that the IEA’s projection for global demand in March was a slight decline of just 90,000 bpd for 2020. Now, the agency’s estimate is for demand to decline by 8.63 mb/d, “96 times more than the estimate on 11 March,” Standard Chartered pointed out. And yet, oil prices are trading in the mid-$30s, just as they were in March.

Supply curtailments have erased much of the glut, but a supply-driven correction means that production can come back online as soon as prices rise to tolerable levels. That, in turn, means that prices are capped to a large degree. “Had the market owed its strength to upside surprises in demand, it could continue past USD 40/bbl with renewed strength,” Standard Chartered said. Instead, the surge in prices is because of supply shut ins, which can quickly be reversed.

The bank estimates that the U.S. could bring 2 mb/d back online with WTI between $30 and $35. And with Brent at $40, the durability of the OPEC+ agreement starts to come into question. As such, “we think the rally is running on fumes,” Standard Chartered said.

“We also do not think that expectations about the global economy have brightened since 11 March, nor have expected timelines for any putative vaccine or return to previous economic conditions shortened,” Standard Chartered warned.

Meanwhile, a second wave of infections remains very possible. In fact, the rate of coronavirus infections is on the rise in at least 12 U.S. states. Rural parts of the U.S. are suffering from the latest surge in cases. Also, the pandemic is only now beginning to explode in places like Brazil and India. It has yet to work its way through much of the world – and could return to previously hit areas that are now reopening.

“[O]verall, the demand backdrop does not justify a return to anywhere near 11 March prices, in our view,” Standard Chartered concluded.

And yet, to much fanfare, New York Governor Andrew Cuomo rang in the New York Stock Exchange on Tuesday, marking the reopening of the exchange’s trading floor. Stocks surged in response.

By Nick Cunningham of Oilprice.com