Oil prices have recovered a bit and we’re beginning to see signs of a realignment in demand and supply. Oil producers and industry analysts are cautiously beginning to ask whether we’ve turned a corner?
Or like my kids on a long car trip: Are we there yet?!?
Maybe…but maybe not.
The front month futures contract for the US benchmark WTI is trading today around $19 per barrel, nearly $60 higher than the first-ever negative price (-$37) seen after the collapse on April 20. The international benchmark of Brent is around $26, up from a 20-year low of $9 on April 21.
There are indeed signs that we may have seen the worst of the demand downturn. The Energy Department’sUS oil consumption estimates have increased for two weeks in a row – by a total of 2 million barrels per day (Mb/d) – after falling by an unprecedented 8 Mb/d (36%) in the previous five weeks. For global oil demand, the International Energy Agency (IEA) expects that April will prove to be the bottom, falling by a massive 29 Mb/d. Declines are expected to moderate to 26 Mb/d this month, and 15 Mb/d by June.
And on the supply side, there are also clear signs of a sharp response. Here in the US, weekly estimates of production show a 1 Mb/d decline over the past six weeks – the sharpest non-hurricane decline on record. In addition to large volumes of existing production being shut-in, we are also seeing a sharp drop in drilling activity, which is a preview of even larger declines in the weeks and months ahead. There are also reports of large-scale shut-ins of production in Canada and Brazil.
Moreover, May 1 marks the beginning of the large production cuts agreed last month by OPEC and cooperating countries like Russia (referred to as the OPEC+ group), which have promised to reduce output by 9.7 Mb/d. And the G-20 countries have endorsed this decision, with President Trump promising that the total reduction will be closer to 20 Mb/d due to a combination of OPEC+ cuts, market-driven declines in the US and elsewhere, and potential purchases of crude for government stockpiles.
So both demand and supply appear to have turned the corner, pushing prices higher after the biggest oil market disruption on record.
Is that the end of the story?
Maybe not.
There’s still too much supply. Every day that global supply exceeds demand, inventories grow. And the problem is that storage capacity is limited.
Even with the adjustments we’re already seeing in the US, inventories still grew by roughly 1.5 Mb/d last week.
Using the IEA’s estimates, the global demand decline of 26 Mb/d expected this month is still significantly larger than the promised global production cuts…so inventories will keep growing. And that’s even before we consider that many of the market-driven production cuts will take time to increase – and assuming that the OPEC+ countries adhere to their new production targets.
We’re already seeing a global inventory system under duress, with crude and refined product tankers being used to temporarily store surplus supplies.
If US and global inventories reach their practical limits before supply and demand come back into balance, there will literally be nowhere for the surplus oil to go.
As a final coping mechanism, the global oil market would have only one path: To drive prices even lower, to force even more producers to shut-in existing production.
Of course, no one can predict future prices – especially in this unprecedented pandemic. Perhaps global oil demand will recover more quickly, and the market-driven supply adjustment will fall more quickly, than expected. Here in the US, the oil rig count has fallen by more than half in less than two months – a much faster decline than we saw in the last market downturn. And, in time, the sharp adjustments we are already seeing will support higher prices.
But for the weeks ahead, continued inventory builds pose significant risks of renewed price declines.
This post originally appeared on the Forbes blog on May 4, 2020.
