Oil on track for best all-month after rebound, but traders say it’s “not out of the woods”

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In the past two months, oil has taken two very different steps, the first of their kind. In April, West Texas Intermediate, the US oil benchmark, fell below zero and into negative territory for the first time in history. Meanwhile, May promises to be the best WTI month ever, dating back to when the contract was created in 1983 – an astonishing month-to-month turnaround.

Improvements in both supply and demand have pushed up prices. Data shows that people in the U.S. and China are starting to hit the road, while producers around the world have cut production at record rates in an effort to drive prices up.

The contract jumped more than 70% in May and posted four consecutive weeks of gains, but some traders warn that the short-term outlook for oil remains uncertain and that prices could return to around $ 20 after settling down around $ 33 on Friday.

In addition, part of the blistered WTI rally this month is due to the historic low from which it rebounded. Prices are still about 50% below the January peak of $ 65.65, which significantly reduces the profits of energy companies, often in debt. A number of US energy companies have already filed for bankruptcy, including Whiting Petroleum, which was once a major player in the Bakken area. If prices remain at depressed levels, there could be more victims.

Still, the market has shown signs of rebalancing, and analysts say if demand continues to improve and producers keep the wells closed, the worst could be over for oil.

“The rebalancing of the oil market continues to accelerate, stimulated by both supply and demand improvements … These improvements eliminate the risk of a sharp drop in prices, even if we reiterate our opinion that the rebalancing will take time, “Goldman Sachs said in a recent note to customers.

“We believe that the next step in rebalancing the oil market will be spot prices linked to the range, the most notable changes being a drop in implied volatility and a continuous flattening of the forward curve without prices in the long term is still not increasing, “added the firm.

“The tide is turning”

As demand for petroleum products fell off a cliff in April, the outlook is improving as economies around the world begin to reopen. Raymond James, who tracks orders for on-site shelters, said that of the 3.9 billion people around the world who were locked out at some point since January, 3.7 billion, or 95%, experienced a kind of reopening.

Chinese demand for oil in April rebounded to 89% from a year earlier, according to IHS Markit, and the company expects May demand to reach 92% of 2019 levels. During the February low, demand in China, the world’s largest oil importer, fell to just 40% from the previous year.

In the United States, all 50 states have started reopening to varying degrees, which means people are driving again. Data from the Energy Information Administration has shown an increase in demand for gasoline, although there is still a long way to go before pre-coronavirus levels are reached.

A worker on an oil well near New Town, North Dakota.

Daniel Acker | Bloomberg | Getty Images

“All eyes are on demand … it’s mainly a demand problem,” said Bernadette Johnson, vice president of market intelligence at Enverus. She sees the WTI oscillate between 20 and 30 dollars in the short term, while demand continues to return. “We expect the third quarter to be better in terms of the supply / demand balance. You need a balanced market to start seeing higher prices. So the third quarter is really the first quarter when we will see this happen, because a lot of the demand is supposed to come back, ”she added.

Evercore ISI echoed this point, writing in a recent note to customers that supply will continue to exceed demand in the second quarter, but that in the third quarter the “tide will turn” when demand will exceed supply .

Record production reductions

On the other side of the equation, historically low oil prices have forced producers to stop production at a record pace. As of May 1, OPEC and its oil-producing allies have taken 9.7 million barrels per day of production offline, after agreeing to the deepest production cut at an extraordinary multi-day meeting in April.

Earlier in May, Saudi Arabia said that as of June 1, it will voluntarily cut another million bpd, in addition to its share of the reductions agreed to by OPEC +. Kuwait and the United Arab Emirates were among the other cartel members who followed suit and said they would also make further cuts.

Norway, Canada and the United States are among the other countries that also announced good closings as oil prices plummeted.

Latest figures from the EIA show that US production fell 1.6 million bpd from its 13.1 million bpd peak in March. Exxon, Chevron and ConocoPhillips are among the companies that have reduced their operations.

Darwei Kung, head of raw materials for the DWS group, said that the rebound in oil prices called for lasting production cuts. But if prices rise enough for producers, including those in the United States, to increase production again, OPEC + may abandon its reductions in order to gain market share.

“We consider that the most important consideration for the supply side of the equation is the ability of OPEC + R countries to remain in the policy of maintaining price stability,” said Kung. “In doing so, they must commit to reducing production even if a third party, such as [the] In the United States, increase production as the price of oil picks up. ”

Second wave of coronavirus cases?

As the oil market begins to rebalance, traders say another big risk is a second possible wave of coronavirus cases and the subsequent return to local shelter restrictions. Francisco Blanch, head of global commodities at Bank of America, said it would have “devastating consequences.”

The firm said the price rebound has occurred faster than expected and forecasts that WTI will average $ 32 per barrel this year and $ 42 in 2021. Bank of America expects international crude Brent benchmark averages $ 37 this year. The contract closed at $ 35.13 a barrel on Friday and also just had its fourth consecutive week of gains.

“It’s not clear if the rest of the world [outside China] can successfully prevent the major recurrence of the spread of COVID-19, given the disparity between countries or states within a country to contain the disease. A second wave of infection can significantly alter the recovery in demand for oil, “added Kung. He noted that sour relations between the United States and China could be another headwind for oil in the future.

“Not out of the woods”

The WTI contract, which plunged into negative territory in April, was for crude oil to be delivered in May. With storage quickly filling, including in the American center of Cushing, Oklahoma, no one wanted to take delivery of oil, as demand should remain depressed in May and June.

Johnson of Enverus said it was the “painful period” necessary to force companies to stop production, and prices plunging into negative territory were working properly. “We’re definitely not off the beaten track,” she said, before adding that the configuration was much better in the second half.

Barclays has a similar forecast, writing in a recent note to customers that oil prices “will remain volatile as participants try to find their way through the extreme distortions caused by a fall in the cliff of demand and a response from industry.” ‘delayed offer’. For 2020, the firm sees WTI on average $ 33 per barrel, before rebounding to $ 50 per barrel in 2021.

– Michael Bloom of CNBC contributed to the report.

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