What's next for oil prices? (Fordítás alatt)

Fundamental look at current situation

Oil did not manage to snap a losing streak in March. Price continued to freefall in April as numerous major economies were locked-down. Aviation and car traffic froze, leading to a 35 million barrel drop in daily demand in April. That is around a third of the total global demand. Meanwhile, supply barely changed. According to Bloomberg supply in Q2 2020 is seen at around 99 million barrels per day. That would be a decline of just 1-2 million barrels against Q1 2020. It should not come as a surprise given that OPEC alone increased output by 2 million barrels per day from February's low. That was more than enough to offset 1 million barrel decline in US production. As a result of an oversupply, global onshore and offshore storage space began to run out. This in turn led to more issues with storing crude and delivering the product causing WTI price to plummet below $0. How will the situation on the oil market look in months and quarters to come?

US oil inventories sit near 5-year highs. Moreover, there is just 150 million barrels of free storage space left in the United States. Should stockpiles continue to increase at their current pace, storage space would run out in 15 weeks. Source: Bloomberg, XTB Research

Tankers are being used as offshore means to store crude. Available data shows that the amount of crude on tankers increased by 20% (or 240 million barrels) since mid-March. It would be enough to satisfy global demand for 3-4 days. Total amount of crude on tankers sits at around 1.3 billion barrels. Source: Bloomberg

Is crude at risk of falling below zero again?

Not long ago an unprecedented situation took place - oil price dropped below. Firstly, it should be noted that this relates primarily to the US crude. Secondly, the situation was triggered by a few factors. The first one is the fact the WTI futures are deliverable. Apart from that, delivery point also plays a role - Cushing is located in the middle of the United States, meaning it has limited capacity of transferring oil to the coast and limited storage capacity. Moreover, interest in passive investment vehicles increased. Low oil prices triggered massive inflows to oil ETFs. As those funds invested in front-month contracts, issues relating to holding open long positions at expiry surfaced. However, recent turmoil caused those funds to spread capital across more contract series. US oil production is declining as well, what should limit inventory builds. Futures curve and spreads also show improvement, signalling the worst may be already behind us.

US oil output dropped by over million barrels in the previous weeks. Given significant decline in the number of active drilling rigs, output may drop by additional 1-2 million barrels. In our opinion production should stabilize near 10 million barrels per day. Source: Bloomberg, XTB Research

M1M2 and M2M3 futures spreads show that the worst may be already behind us. Source: Bloomberg

Will we see quick demand recovery?

Demand destruction caused by Covid-19 pandemic is enormous. Some estimates point to a 35 million barrel decline in daily demand in April. The most optimistic forecast says that daily demand in Q2 will be 12 million barrels lower compared to end-2019, or around 88 million barrels per day. Our estimates signal that in the best case scenario demand could recover to 90-95 million barrels this year. Taking a look at the situation in 2008, one can see that oil demand saw 5 quarters of decline and recovered to 2007 levels after 10 quarters.

Of course, we are currently observing a slow return to normal. Monthly data on traffic shows that it has increased by more than 22% in the United States and Canada. Similar data is available for Germany, Italy, South Korea or India. Japan, Taiwan and Singapore can be seen as exceptions. Overally, improvement in traffic is seen in daily, weekly and monthly data all over the world.

Goldman Sachs and Morgan Stanley expect price to stabilize soon and forecast moderate rebound towards $50-52 in 2021. Assuming that demand at the end of this year will be 90-95 million barrels per day, $50 price tag should stabilize the market.

IEA expects strong demand recovery in the second half of 2020. This is a very optimistic forecast but demand could recover toward 90-95 million barrels per day at year's end. Source: IEA

$50 per barrel should be the price stabilizing market based on marginal costs. Source: Wood Mackenzie

What's next for prices?

Facts presented above point to a long period of oversupply. Market may be driven in short-term by news of production cuts or OPEC+ deal being adhered to. Price could continue to gain and reach the $28-30 area when it comes to WTI. Brent could rise towards $38-40 per barrel.

However, the market will also react to long-term fundamental factors. Big oversupply should lock the price within a sideways trend with $18-20 serving as the lower limit for WTI ($25 for Brent). As the history of previous crises taught us, the sideways trend may last months.

It is worth paying attention to Brent futures traded on ICE exchange. In the case of Brent futures, there was no big increase in the number of open positions triggered by ETFs. Having said that, this grade of oil may be more informative when it comes to short-term trends on the oil market.

Oil market may have already bottomed out. However, history suggests that the sideways trend, lasting even months, should follow. Source: Bloomberg, XTB Research

Number of short positions on Brent is being reduced significantly. Similar situation took place in 2016, mid-2017 and the turn of 2018 and 2019. Upward move may continue until long and short positions converge. Source: Bloomberg

WTI price is nearing the supply zone in the $28-30 area. Key resistance can be found at $35 per barrel - a peak that followed March's sell-off. Source: xStation5