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Oil market mulls demand risks

Crude price comes under pressure from concerns over a second coronavirus wave just as Opec+ considers loosening the supply taps. But are the worries overdone?

The Nymex WTI crude contract dipped back below $40/bl on Tuesday morning, while Ice Brent struggled to hold its ground above $42.50/bl. Fears that a resurgence of Covid-19 in the US might take a chunk out of demand just as Opec+ announces a relaxation of production cuts at its Wednesday meeting set the bearish tone.

The concern is understandable—the UKs’ Office for National Statistics (ONS) released figures on Tuesday morning that showed the country’s economy rebounding more slowly than expected in May, emphasising he fragility of demand. But there are also more positive demand-side factors of that traders should be mindful beyond the headlines coming out of large US states.

Production boost

Opec’s Joint Ministerial Monitoring Committee (JMMC) is expected to endorse a c.2mn bl/d production increase when it meets on Wednesday, says Helima Croft, head of global commodity strategy and Mena research at bank RBC Capital Markets. This has, in her view, some supply-side risk, as “more errant producers” could at the same time backslide from their commitments to quotas and reduce compliance.

2mn bl/d – Expect output increase

But demand is the bigger worry. “The most pressing concern for the group is whether it can quickly change course if the demand outlook deteriorates because of the re-imposition of shelter-in-place restrictions in key geographies,” says Croft.

Opec+ faces a decision “at a time when Libya [may attempt] to restore production [and] US stocks are close to record levels while the pandemic is far from under control, especially across the three biggest fuel-consuming US states”, agrees Ole Hansen, head of commodity strategy at Denmark’s Saxo Bank.

A 2mn bl/d loosening of Opec+  curbs “should not come as a surprise”, notes Louise Dickson, oil market analyst at consultancy Rystad Energy. “That was the plan in the first place and it should have already been priced in.

“[But] the transition to higher production coincides with a move back to movement restrictions in populous US states and other countries around the world,” says Dickson. And, in addition to 2mn bl/d of Opec+ supply—a “significant amount in the current market”—Dickson also expects the $40/bl+ price environment to usher back in some shut-in non-Opec supply.

“Where will extra oil go now if people are ordered back to their homes to reduce spread?” she asks. In her view, the tick-up in road fuel demand moved the market upwards, so transport restrictions are particularly concerning.

Reasons to be cheerful?

On the other hand, even if Opec+ looks at the risks and concludes they are worth taking to reduce the burden it has taken on itself to help balance the market, it will still be cutting 7.7mn bl/d, says Dickson.

In the US, “disturbing trends have emerged at the local level”, according to consultancy BCA Research. The last week has seen Arizona, Texas, Florida and California set record single-day Covid-19 mortality rates. Google Mobility data shows movement of people has been declining in those first three states since mid-June and has flatlined in California, BCA notes. Even in New York, where death rates are falling, the increase in mobility rates has slowed.

“As the second wave continues to grow in certain states, the pace of the US economic recovery will wane,” BCA predicts. “Nonetheless, we do not except a repeat of the catastrophe that struck the economy in March and April. At-risk individuals are better isolated and the population at large is generally more aware, while health authorities are better prepared than in the spring. Additionally, the pain of the lockdowns is wearing thin. These factors suggest that if lockdowns re-emerge, they will be more limited than in March-April.”

It is also worth remembering that “Europe is re-opening and its second wave remains marginal,” the consultancy notes. “Consequently, European mobility is improving faster than in the US, a trend that is likely to continue as the US second wave expands.”

Oil traders should keep the headlines emanating out of the US southern states in mind as they weigh up the impact on any Opec+ reduction in cuts. But they should also bear in mind that California, Florida and Texas are by no means the global story.

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