Crude oil pausing with focus on compliance and EIA stock report
Head of Commodity Strategy
Summary: The crude oil rally that kicked off following the sub-zero collapse five weeks ago have paused. A potential US inventory build and concerns about Russian production cut commitments are currently off-setting a recovery in demand as lock-downs continue to be lifted around the world.
What is our trading focus?
OILUKJUL20 – Brent Crude Oil (July)
OILUSJUL20 – WTI Crude Oil (July)
XOP:arcx – Oil & Gas Exploration & Production
XLE:arcx – Energy Select Sector SPDR Fund (Large-cap US energy stocks)
The crude oil rally that emerged following the sub-zero collapse on April 20 is showing the first signs of pausing. This after the WTI futures contract hit $35 resistance and Brent failed to challenge $37.2/b, both levels being the 38.2% retracement of the January to April sell-off. The brief collapse into negative territory last month on the expiring May WTI contract probably was the single biggest contributor to support the strong rally that followed.
A break above $35/b on the July WTI futures contract could signal a potential extension towards $40/b while support should emerge at $30/b. Only a break below $28/b would raise concerns of a deeper correction.
The event on April 20 sent a shock-wave through the global oil market with producers realizing that something dramatic had to be done in order to rescue the market from even more pain. This probably led to the very strong and rapid compliance that major producers have been exhibiting so far this month.
In their latest monthly Oil Market Report the International Energy Agency saw global supply drop by 12 million barrels/day in May to reach a nine-year low at 88 million. Demand meanwhile was expected to recover from being down 22 million barrels/day year-on-year in May to down 13 million in June.
Supporting the process has been the rapid and in most cases involuntary reduction in US shale oil production, now estimated by the IEA to reach 2.8 million barrels/day year-on-year in 2020. Previous production cuts by OPEC+ always attracted some level of hesitancy as members of the group risked yielding further market share to producers in North America. That risk evaporated with the slump in WTI as it left many producers out of pocket, thereby forcing them to halt production.
Having potentially reached the consolidation phase it is worth considering what could trigger a renewed sell-off. There are several risks with the most relevant being:
- Easing lockdowns sparking a resurgence of Covid-19 outbreaks
- Can OPEC+ maintain the current high level of compliance
- Cash strapped US producers desperate to increase production with WTI back above $30/b
- Post-pandemic changes in global consumer habits (less flying and work from home)
Hedge funds through futures and retail investors (unfortunately) through futures-tracking ETFs, such as the much talked about USO, have been buyers for the past seven weeks. Especially the demand for WTI crude oil futures have been firm with the net-long during this time seeing a three-fold rise to a 20 month high. Hedge funds will maintain and add to this exposure as long the fundamental and not least technical outlook continue to support. But be aware of the potential risk of long liquidation should some of the above mentioned risks come to fruition.
The mentioned consolidation the market is currently witnessing emerged following reports that Russian producers were sowing doubts about their commitments to maintain current production cuts beyond July. The rapid improvement in supply/demand fundamentals seen during the past month has primarily been driven by supply cuts with the pick-up in demand playing second fiddle. On that basis the recovery remains fragile as extra supply could be added at a relative short notice. Demand therefore needs to continue its trajectory higher, especially during the important summer driving season.
Later today at 1500 GMT the US Energy Information Administration will release its ‘Weekly Petroleum Status Report’. Crude oil extended declines the American Petroleum Institute last night reported that US crude oil stockpiles rose by 8.7 million barrels last week. Thereby contradicting surveys pointing to a 1.9 million barrels drop.
As per usual it is not only the level of crude oil stocks that will attract attention. Equally important as per the charts below is to follow developments in motor gasoline demand from US motorists, refinery activity and not least the latest estimates for US crude oil production, down 1.6 million barrels/day from the early March peak above 13 million barrels/day.
As per usual I will publish the result and charts on my Twitter handle @Ole_S_Hansen