Head of Commodity Strategy
Summary: Crude oil's recent recovery has run out of steam as the overhang of supply continues to weigh on the market. This despite signs that activity in China has begun to slowly pick up and the government has stepped up its efforts to support the economy. The demand shock has created a major challenge to the OPEC+ group of producers and so far they have failed to agree on any additional production cuts
Crude oil's road to recovery remains long and paved with obstacles. A short-lived spike at the beginning of January on geopolitical developments quickly gave way to the dual negative impact of rising non-OPEC production and more importantly the Covid-19 outbreak in China. Demand for fuel products in the world's second largest economy is estimated to have dropped by more than 3 million barrels/day with major cities under lock-down and travel restrictions in place.
With these developments in mind the market has once again been turning to the OPEC+ group of producers for support. In addition to existing OPEC+ cuts a 600,000 barrels/day reduction has been discussed but not yet approved. While Saudi Arabia who needs crude oil closer to $80/b than the current $50/b has supported the reduction Russia has so far not made any commitment. The combination of a much lower fiscal breakeven price and a weaker Ruble has made the Russians less exposed to the latest price slump.
From a chart perspective the upside potential for Brent crude oil looks limited to $60/b while the low point, depending on the length of the virus disruption may have yet to be found.
Monthly oil market reports from the US Energy Information Administration, OPEC and the International Energy Agency, released last week, all tried to gauge to impact on demand from the current virus disruption. While OPEC lowered its 2020 world oil demand forecast to 1 million barrels/day in 2020, the IEA went a few steps further and cut demand to 0.83 million barrels/day, the lowest since 2011.
The chart below shows why global oil prices are under pressure as the gab between non-OPEC production and world demand continues to widen. The IEA in their Oil Market Report wrote
"The call on OPEC crude plunges to 27.2 mb/d in 1Q20, which is 1.7 mb/d below the group’s January production of 28.86 mb/d." It continued "From the point of view of the producers, before the Covid-19 crisis the market was expected to move towards balance in the second half of 2020 due to a combination of the production cuts implemented at the start of the year, stronger demand and a tailing off of non-OPEC supply growth. Now, the risk posed by the Covid-19 crisis has prompted the OPEC+ countries to consider an additional cut to oil production of 0.6 mb/d as an emergency measure on top of the 1.7 mb/d already pledged"
The current price weakness has occurred despite a dramatic and involuntary loss of production in Libya. Since January 18 its output has slumped by close to a million barrels/day because of a blockade of ports and oilfields.
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As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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