Scraping the barrel – Guest Analysis

By Stephen Innes, Chief Global Market Strategist, AxiTrader

The anarchy in the streets of major metropolitan areas across the US in the wake George Floyd’s death threatens to throw a wet blanket on the price recovery over the short term as investor optimism over economic reopenings in the US could wane. If American consumers were reluctant to come out of their Covid-19 lockdown cocoon fearing a secondary spreader, with police cars ablaze, freeways blocked and videos of mass looting shared through social media like wildfire, they’re not going to feel any safer. 

Crude oil price rose to end the week on a positive tone despite confirmation of the crude build in the EIA data that the API flagged up in the session before. Nonetheless, US-China tensions weighed through the early part of Friday. At the same time, the crude build didn’t help, albeit its primary source was a significant rise in Saudi imports that one could validly claim was already in the price after trackers had flagged the oil Armada heading for the US weeks ago.

Reports ahead of the June OPEC meeting suggest that Saudi Arabia is considering proposing extending the 2Q cuts further into 2020, but traders remain wary of a Russian pledge.

A phone call last week between Saudi Crown Prince Mohamed bin Salman and Russian President Putin should put some of those pre-OPEC meeting jitters on the back burner; sources suggested the call resulted in a reiteration of a commitment to continue cooperation on supply cuts, reducing the risk of a split at the OPEC+ meeting on June 9.

Still, doubts remain that Russia might not go along with an OPEC decision to extend the duration of the initial two-month period of deepest production cuts within the OPEC+ agreement and that they’d begin phasing out cuts from July. While the fundamental impact of that would be limited, any sign of conflict between the two countries contributing the most to the OPEC+ agreement would provide poor optics and bring back memories of the March oil price war that started this oil market fiasco. 

On Friday, Baker Hughes reported that the number of active US rigs declined by 15 to 222 this week. The oil rig count has now fallen for 11 weeks in a row, hinting of more CAPEX divestment in US oil production and a sharper downward adjustment in drilling activity than in 2015. All of which is indicating greater discipline and may moderate future supply growth, which is very bullish for oil.

The market will take note of the impressive recovery in Chinese refinery production, in addition to the tasty eye candy from both Google and Apple mobility tracking data. With the US only a third of the way up from the trough in US product demand, there’s no reason the US refineries can’t gradually fill that gap as more and more US states relax lockdown measures and more consumers hit the roads.

While only a vaccine will signal all systems go, there’s still plenty of room for refining run rates to rise when mapping to the comparable uptick on run rates to Chinese refinery demand. 

With indications of strengthening and continued OPEC+ commitment amid signs that OPEC+ resolve will last at least through the end of the year, oil prices should continue to rise if the current OPEC+ compliance commitment argument for price recovery holds water.

But given the substantial rise in US oil inventories last week, it suggests we’re not out of the woods just yet.

Crude inventories are building outside of Cushing and product stocks are still rising. US crude stocks have now been broadly flat for the past four weeks – the glut has even shifted from Cushing, where NYMEX WTI futures settle, to other regions. Cushing stocks were down again last week and are down 12mb since the start of May, while Gulf Coast crude stocks have risen 12.5mb over the same period.  

Meanwhile, stocks of oil products continue to build. The build-in distillates have been particularly quick and worrisome. Unless it reverses this week, it may act as a headwind to further near-term improvement in crude prices as the recovery in product demand hit the brakes last week, highlighting how the nascent demand recovery will be anything but smooth sailing 

Fortunately we’re in the typical period of seasonally rising refining runs. Sadly, the past historical correlation could prove meaningless in a Covid-19 environment as past consumer consumption behavior is not necessarily transferable. 

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