Energy Prospectus

WTI crude futures settled 2.4% higher at $40.6 a barrel on Friday, little-changed on the week, after reports that Gilead Sciences’ antiviral drug remdesivir reduced mortality risk in COVID-19 patients by 62%. Prices also found support after the International Energy Agency (IEA) raised its 2020 oil demand forecast, following the easing of coronavirus lockdown measures in several countries across the world, while Baker Hughes' data showed US energy firms cut the number of oil and natural gas rigs operating to a record low for a 10th week in a row. On the supply side, data from both the EIA and API showed a surprise build in US crude inventories last week, the result of higher imports than expected. Refinery utilization continues to inch higher and gasoline inventories are back to less than 30 days of supply.

In its latest monthly report, the IEA said it is now projecting demand will fall by 7.9 million barrels this year to 92.1 million barrels a day, an improvement of 400,000 barrels from its last forecast. It is also forecasting a recovery in 2021 to 97.4 million barrels a day.

At $40.60/bbl, the front month NYMEX contract for WTI rose $0.28 during the week and is now up $23.52 since April 30.

FEAR of renewed shutdowns due to the increasing number of COVID-19 cases is keeping pressure on oil prices. The media has been ignoring the declining mortality rate. Doctors across the globe have come up with much better treatments for the disease. In April the death rate as a percentage of active cases was ~6% today it is ~1%. Widespread shutdowns should only be necessary if the number of serious cases starts to overwhelm the hospital system; that is not happening.

Oil production and oil demand are now in balance. The next task is working off the above ground inventories.

As I covered in Thursday's webinar, the FEAR that U.S. upstream companies will ramp up drilling activity now that WTI is over $40/bbl is way overblown. 2020 D&C budgets are now locked in. Some companies are bringing back online wells that were shut-in and a few completions crews have gone back to work. This activity should stabilize U.S. oil production around 11 million BOPD, but the decline rate will win the battle since we aren't running even half the number of drilling rigs necessary to hold U.S. oil production flat.

The IEA July 10, 2020 Oil Market Report (OMR) Highlights

●Global oil supply fell by 2.4 mb/d in June, to a nine-year low of 86.9 mb/d. Robust compliance with the OPEC+ output deal and steep declines from other producers, led by the United States and Canada, has cut world oil output by nearly 14 mb/d since April. If the OPEC+ cuts stay in place as agreed, global supply could fall by 7.1 mb/d in 2020 before seeing a modest recovery of 1.7 mb/d next year.

●Global oil demand fell by 16.4 mb/d year-on-year in 2Q20 as lockdowns were imposed to combat the Covid-19 pandemic. Demand rebounded strongly in China and India in May, increasing by 0.7 mb/d and 1.1 mb/d m-o-m, respectively. World oil demand is projected to decline by 7.9 mb/d in 2020 and to recover by 5.3 mb/d in 2021. The recent increase in Covid-19 cases and the introduction of partial lockdowns introduces more uncertainty to the forecast.

●For refiners, any benefit from improving demand is likely to be offset by expectations of much tighter feedstock markets ahead. Refining margins will also be challenged by a major product stocks overhang from the very weak 2Q20. In China, throughputs in June were estimated at a record level of nearly 14 mb/d. Global refinery runs are forecast to fall by 6.4 mb/d in 2020 to 75.1 mb/d and increase by 4.7 mb/d in 2021.

●OECD industry stocks rose by 81.7 mb (2.64 mb/d) to 3 216 mb in May, rising by 2 mb/d since the end of 2019. In the US, preliminary data for June show that commercial stocks built by 24.7 mb (0.8 mb/d), led by products. In June, floating storage of crude oil fell by 34.9 mb from its all-time high in May to 176.4 mb. A tightening crude market balance and a flatter forward price curves reduced the incentive to store oil.

●Crude prices increased in June for the second successive month. North Sea Dated prices oscillated between $38-$43/bbl, supported by tighter fundamentals but capped by rising numbers of Covid-19 cases and economic uncertainty. By early July, prices were firmly above $43/bbl. The flatter contango seen recently will encourage crude stock draws. With ample stocks, product prices lagged crude, squeezing cracks and refinery margins. Freight rates continued to ease over the month.

Commentary

We started the second half of this extraordinary year hoping that the worst of the oil market turbulence is behind us. A recovery in economic activity is shown by various indicators, including improved mobility in many regions (see Demand). However, the strong growth of new Covid-19 cases that has seen the re-imposition of lockdowns in some regions, including North and Latin America, is casting a shadow over the outlook. Only time will tell if the economic impact will be serious. In the meantime, in the past few weeks benchmark crude oil futures prices have been remarkably stable with both Brent and WTI hovering around $40/bbl and the contango seen in both futures curves has flattened. In the case of ICE Brent, we even saw a few days of backwardation in June. Futures markets are anticipating a transformation in the oil market from substantial surplus in the first half of the year to a deficit in the second half.

In this Report, new data confirm that the worst of the demand destruction was in the first half of the year when demand fell by 10.75 million barrels per day (mb/d). For the second half we expect an improvement in the level of decline to 5.1 mb/d. We estimate that global oil demand this year will average 92.1 mb/d, down by 7.9 mb/d versus 2019, a slightly smaller decline than forecast in the last Report. This is mainly because the decline in 2Q20 was less severe than expected. For 2021, we have made some minor adjustments to our outlook and demand will be 97.4 mb/d; but due to the improved outlook for 2020 the recovery next year is lower at 5.3 mb/d. Average demand in 2021 will be 2.6 mb/d below the 2019 level with jet/kerosene accounting for three-quarters of the deficit.

On the supply side, global oil production fell sharply in June to stand 13.7 mb/d below the April level. The compliance rate with the OPEC+ supply agreement was 108%. This includes over-performance by Saudi Arabia which cut production by 1 mb/d more than required, reducing OPEC crude output to its lowest point in nearly three decades. This solid performance by the OPEC+ group has been supplemented by substantial market-driven cuts, mainly in the United States. Total US oil production fell by nearly 1 mb/d in April versus March and we estimate that May and June will see further month- on-month falls of 1.3 mb/d and 0.5 mb/d, respectively. However, in the second half of the year supply could start to grow: we see US production bottoming out and then slowly growing and OPEC+ countries are set to ease their existing cut by around 2 mb/d from August. Also, by the end of the year Libya’s oil production could be as much as 0.9 mb/d higher than it is today.

While the oil market has undoubtedly made progress since “Black April”, the large, and in some countries, accelerating number of Covid-19 cases is a disturbing reminder that the pandemic is not under control and the risk to our market outlook is almost certainly to the downside.