For the oil markets, the first half of the year saw extraordinary swings in supply and demand, culminating in what is now thought to have been a staggering 22mbbpd of oversupply in April as OECD economies headed into lockdown and OPEC+ cuts dissolved. Demand fell to 78mmbpd and Saudi Arabia pumped an additional 1.6mmbpd, driving Brent down to under $10/bbl on April 21st and briefly pushing the WTI futures contract into negative territory.
Since then the supply demand balance has improved remarkably. A big, new OPEC+ agreement saw a 9.7mmbpd cut come into effect in May and now extended through July. To date, monthly compliance has averaged 96%, with Saudi Arabia compensating as usual for OPEC laggards and Russia adhering to its 2.5mmbpd pledged cut . More recently, a July meeting of the JMMC agreed to taper cuts to 7.7mmbpd from August through to the end of the year (a further reduction to 5.8mmbpd is then planned through 1Q2022). The effective cut could be nearer to 8-8.5mmbpd for August/September if the suggestion that serial non-compliers such as Nigeria and Iraq make up for any shortfalls in compliance in May and June. Out with OPEC+, supply has fallen by around 3mmbpd since March and in the US the EIA reports a 2.1mmbpd fall in crude production in June from a 13 million barrel a day peak in the first quarter of the year.
Westwood now estimates that overall oversupply for the first half of the year was . However, the subsequent rapid reduction in output, coupled with US-led demand recovery, has now likely seen the global oil market flip to a net draw position of 1.3mmbpd in June. This switch to an undersupplied market will be critical to eroding the estimated 1.2 billion barrels of excess supply accrued in storage between January and May. This process looks to have already begun. According to the IEA, oil in floating storage fell by 16% in June and the EIA reported a draw in commercial crude stocks in July for the first time since March. Another indication of the rapidly shifting supply/demand dynamic is the almost $7/bbl swing in the Urals/Brent differential between April and May, as recovering Chinese refiners paid a premium to secure diminishing, yet still heavily discounted Russian crude.
The outlook, of course, remains a minefield of uncertainty. On the supply side the two burning questions will be the ability of Saudi Arabia to continue to marshal cut-compliance if oil prices continue to rise, as well as the ability of US output to recover at $40-45/bbl WTI. Whilst the CEO of Parsley Energy, Matt Gallagher, recently declared that US production will not reach 13mmbpd again in his lifetime (he’s only 37!) others such as Noble, Continental & ConocoPhillips have already announced their intention to bring back some of the capacity curtailed over March-June.
On the demand side, the outlook is even more up in the air . The most recent IEA demand outlook suggests that whilst the height of demand destruction back in April may not have been as bad as first thought, third quarter recovery will now likely be slower than previous estimates, as China reduces its strategic crude purchases and regional lockdowns threaten OECD economies once more. Even by the fourth quarter, consumption is likely to retain at least a 3-4mmbpd kerosene-shaped hole year-on-year due to international quarantines and a reduced appetite for air travel.
Westwood estimates that 3Q could see an average draw of 5.2mmbpd over the balance of the year, dropping to 1.6mmbpd for 1H2021. This assumes OPEC+ compliance remains above 95%, and US oil production grows only marginally and that the IEA’s latest demand projection plays out. Under this scenario the supply glut would be eroded to pre-pandemic levels by August of next year. This should support oil prices moving to the $50-$55/bbl range in 2021. Beyond this, the uncertainties multiply, not least the potential 4.2mmbpd of exports that are currently off the market from Iran, Libya and Venezuela, which loom large and may yet derail any price recovery in the next couple of years.
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