In the build up to NBAS’ webinar Volatile oil prices – how they affect the industry on 11 June 3pm SST/ 9 am CET, featuring world leading oil analyst, Amrita Sen, her company Energy Aspects offers their input to the discussion.
This article is written by Caroline Still, Analyst, Cross Energy at Energy Aspects
Sign up for the webinar Volatile oil prices – how they affect the industry on 11 June 3pm SST/ 9 am CET here.
Oil price fluctuations will have lasting impact
At Energy Aspects, we think that the recent price volatility is mainly attributed to the extraordinary shifts in market fundamentals seen over the last few months. However, financial positioning has also helped to magnify these price-swings, like we saw with the May West Texas Intermediate (WTI) contract going negative.
The initial market shock of the COVID-19 demand destruction hitting at the same time as OPEC’s record supply surge in April pushed crude inventories to their absolute limit and caused the price crash.
Shocks of this magnitude almost always lead to overcorrections as the market tries to rebalance, like a pendulum finding its centre. This is especially true of a demand-led market due to the lag of the supply-side response. These overcorrections explain the subsequent price volatility that we have seen, and this will continue to play out in the months to come.
No straight-line recovery
The pandemic brought April’s demand down to an extraordinary 78.6 mb/d, from 2019’s 100.3 mb/d average. The path to recovery from this trough is opaque, varies across products and regions and has led to uncertainty and speculation which amplifies the market’s reactions to fundamentals.
We maintain that although demand seems to be recovering faster than expected as the Chinese engine restarts (we have raised our May global demand estimate to 86.1 mb/d), we do not expect global demand to recover to pre-pandemic levels until after 2021. The market is yet to come to terms with the fact that this will not be a straight-line recovery in either the global economy or oil demand. Rising numbers of new cases will force governments to reinstate some form of stringent social distancing measures even if not as severe as those in April.
Regardless, hopes of a more rapid demand recovery, stronger buying from eastern refineries and the announcement of additional GCC supply cuts for June have supported prices recently. However, we feel prices have risen too far too quickly. This overcorrection could lead to some shuttered wells being brought back to production (US) and will encourage cash-strapped OPEC countries to cheat on production quotas.
The narrowing contango will also trigger the release of some barrels from storage. This returning supply risks creating a second, albeit smaller, supply glut later in the year long before demand has recovered. This possible overcorrection then risks subsequent weakness in H2 20.
Essentially, if the market overshoots to the upside now (just as it overshot to the downside in April), there remains the possibility that we see another downward correction again in H2 20. Although volatility might not be the “new-normal”, supply and demand shocks of the magnitude experienced in April will take months to recover from as the market swings from panicking about demand to panicking about supply.
In the longer-term, production will take several years to recover to pre-COVID-19 levels. Looking beyond the logistical and economic shut-ins required to balance the Q2 20 oversupply, should prices remain low, there will be more lasting medium-term implications from the $125 billion of Capex reductions implemented since the beginning of March.
Lower activity will manifest itself as higher decline rates and reduced reservoir pressure from prolonged well shut-ins around the world. This underpins our expectation for a price spike from 2022, once the inventory overhang has been worked through over H2 20 and early 2021. However, if prices recover too quickly now and prevent a market-led rebalancing of supply shut-ins, the supply overhang could linger well into 2021.
Ultimately, the price fluctuations of this year and the short-term market balancing will have lasting impacts on the storage overhang of 2021 and the resultant price signals sent to upstream suppliers well into the early 20s.
About Amrita Sen
Amrita Sen is the co-founder, Director of Research and Chief Oil Analyst at Energy Aspects. Amrita’s specialism is in energy commodities, particularly oil and oil products. Amrita holds a PhD from SOAS, University of London, an MPhil in Economics from Cambridge University, and a BSc in Economics from the University of Warwick. She was formerly the chief oil analyst at Barclays Capital. Amrita is frequently featured in leading media outlets, including the Financial Times, BBC News and Bloomberg, and she is regularly invited to present at conferences. Amrita will be taking part in the NBAS webinar on 11 June to discuss the recent extreme volatility in oil prices.
About Energy Aspects
Energy Aspects is an independent energy research consultancy. It analyses market fundamentals, tradeflows, geopolitics and forecasts price movements. Energy Aspects provides insight into energy markets that is data-driven and is delivered in a timely fashion to clients in a language that they understand.