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Brent is likely to find support in June in the range of $35-40/barrel

Paul Hickin, associate director at S&P Global Platts
A faster-than-expected recovery in oil demand and the decision by top oil producers to extend production cuts have given the oil market a much-needed shot in the arm. However, the sector remains bloated with oil stocks, flush with spare capacity, and replete with producers eager to pump again. A fully-fledged recovery remains premature.

OPEC and its allies, led by Russia, sent all the right signals at their latest meeting, suggesting the grouping has a handle on Covid-19-induced volatility. The pact, known as OPEC+, agreed to roll over its deep production cuts – amounting to around 10 per cent of global supply – that it had in place for May and June through to July. It also aimed to clamp down on those producers with a flaky record of sticking to their output reductions. Under the deal extension, Iraq, Nigeria, Angola and Kazakhstan have committed to compensating for their lack of compliance in May with additional cuts in July, August and September. While their excuses or explanations were tolerated in the past, the stakes are so much higher at this juncture.

The alliance is also looking to be flexible, given the huge degree of uncertainty and rapidly changing market environment. A monitoring committee, co-chaired by Saudi energy minister Prince Abdulaziz bin Salman and Russian energy minister Alexander Novak, will meet monthly to assess compliance with quotas and also gauge the market’s recovery, so that the coalition can adjust its cuts, if needed.

Saudi Arabia, the de-facto leader of OPEC, also shares the market’s tentative enthusiasm that demand may have turned a corner. State-run oil company Aramco has aggressively raised its July crude export official selling prices across the board, which the Saudi energy minister said was a “good indicator that demand is coming back and thriving.”

Major Asian crude importers China, Japan and South Korea are showing signs of returning demand as coronavirus-linked restrictions on work and travel relax. Traffic on roads and highways has increased in South Korea, pointing to a recovery in gasoline demand. Crude demand from China is recovering ahead of the rest of Asia and expected to continue at an upbeat pace during June and July, traders based in the country have told S&P Global Platts.

It's easy to see why Dated Brent – the physical benchmark used to price two-thirds of the world’s oil – has tripled in value since hitting a 21-year low in April. The measure of high-quality North Sea crudes is now trading at around $40 per barrel. S&P Global Platts Analytics notes that Dated Brent prices are likely to find support in June in the range of $35-40/barrel as supply shut-ins peak, demand recovers, and OPEC+ maintains discipline.

Key challenges

The oil market faces a number of challenges it must overcome before it can continue its positive momentum. The first involves clearing 1 billion barrels of excess oil held in storage on land and on water. A glut of crude and oil products filled tanks and caverns earlier this year before large tankers at sea were chartered to store the surplus and this is likely to take months to clear. Secondly, higher oil prices have already started to result in lower shut-ins to production, with some operators in the US now beginning to bring production back online. US output is now down 1.9 million b/d from its mid-March record high of 13.1 million b/d, according to data from the US Energy Information Administration.

Platts Analytics estimate that volumes will gradually come back over the next three months as the oversupply is reduced and prices stabilise. However, some volumes will take longer to come back and some will never return. Shale’s response to the price recovery could play an important role in capping that very same price increase as it has done in the past. The battered industry may not bounce back in the same way.

There is also the spare capacity from all those producers that have cut supply as part of the OPEC+ deal. Unwinding from the agreement, whenever that comes, could be just as difficult as sticking to the cuts as the market share battle resumes. Iran, Libya and Venezuela also remain wild cards given their various difficulties but with huge production potential. 

Finally, the spectre of a second wave of Covid-19 infections during the latter half of this year will haunt the market. Risks of second wave hits of Covid-19 globally have also increased, with recent mass protests globally and challenging infection rates in Latin America, the Middle East, South Asia and Africa, Platts Analytics notes.

The speed at which the oil market rebounded to $40 per barrel has certainly grabbed attention, but the oil market needs to walk before it can run.
London-based Paul Hickin is associate director at S&P Global Platts. Views are his own.

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