Friday, March 27, 2020

Will pressure from both demand and supply issues pressure oil prices more?

  • Oil
  • Brent


Analysts’ Pick: Will pressure from both demand and supply issues pressure oil prices more?

  • Outlook for crude oil prices look tilted towards the downside as a result of a demand crunch and high volatility
  • A significant oversupply in the crude oil inventories as Saudi Arabia, UAE and Russia ramp up output and compete for market share will weigh on oil prices as well
  • We expect oil to trade near U$25 per barrel in the short-term, although high volatility may send oil prices lower than that

Crude oil prices face issues from both supply and demand as a result of a fallout between OPEC+ members amid the coronavirus outbreak. We expect oil prices to remain low, roughly around the US$25 per barrel mark with risks skewed towards the downside. In addition, volatility is also expected to remain high, resulting in large swings in oil prices although this is unlikely to be sustained in the long-term. Crude oil prices should only start to rebound when volatility softens, with upside potential as a result of a global economic recovery and improving travel conditions.

Volatility in crude oil prices were amplified by both the coronavirus outbreak and breakdown in OPEC+ talks


At the start of 2020, the outlook for oil was already dampened by reduced demand from China, as a result of an extended Lunar New Year holiday which saw multiple factories closed and travel plans cancelled. The number of flights to China were also greatly reduced in a bid to prevent a global spread of the virus. Now, with the virus spreading at a rapid rate across the globe, the airline industry is forecasted to experience a large dent to its overall revenue. The International Air Transport Association (IATA) estimates that air traffic in Europe, US and Asia will decline 46%, 27% and 37% respectively. With more than 7,500 commercial aircrafts grounded worldwide as countries go into lockdown, demand for jet fuel and consequently crude oil will decline.

The number of cases of the virus has risen exponentially even though China’s count of new cases has slowed down


Furthermore, with unemployment numbers expected to skyrocket as companies cut workers to reduce costs to keep cash flows positive, we should also see demand for transport decline, which also contributes to demand for crude oil. Weak consumer sentiment will likely also weigh on crude oil demand. Chinese factories coming back online should help to somewhat mitigate the fall in demand although with many manufacturing-focused cities being on lockdown, we do not see a rebound in demand for energy in the short-term.

Cities with factories focused on manufacturing


Heatmap of cases of the coronavirus across the world


On the supply side, oil prices sank when OPEC+ meetings fell apart during its last meeting earlier in March as Russia and Saudi Arabia failed to reach an agreement during the meeting on production cuts to help relieve some pressure of oil prices amid the coronavirus crisis. The fallout resulted in Saudi Arabia instructing state-owned oil producer Saudi Aramco, to increase its maximum sustainable capacity from 12mn barrels per day to 13mn. Abu Dhabi National Oil Company (Adnoc) also followed Aramco's lead, increasing its own supply to 4mn barrels per day from an average of 3.04mn barrels per day in February. Moscow also pledged to increase its production capacity by 300,000 barrels per day and possibly 500,000 barrels per day in the near future. The flood in supply in the market will keep oil prices under pressure for a sustained period of time, especially when the outlook for oil demand in the year is likely to remain flat at best.

While Russia indicated that it remains open to more negotiations with OPEC+ members, it is unlikely that the cartel will reach an agreement soon. Another dynamic that affects oil prices in the short-term is US shale oil. With lower crude oil prices, we expect US shale oil companies to suffer. This is due to the higher cost of production for shale oil in the US. It is estimated that shale producers breakeven at prices ranging from US$26.90 to US$65 per barrel, although most shale producers budgeted production costs nearer towards US$55 and US$65 in 2020. As both Saudi and Russia compete for more market share in the energy sector, US shale oil producers’ share of the market is likely to erode as its attractiveness as a close substitute to crude oil declines. In addition, the cost of production for crude oil is much lower (Saudi Arabia’s cost of crude oil production is estimated to be roughly US$3 per barrel, although it needs crude oil prices to be at roughly US$55.30 per barrel to maintain a current account balance of zero), allowing Saudi Arabia to keep high outputs in exchange for lower prices and slightly higher selling volumes. Russia's economy is also less reliant on oil as it is more diversified, enabling it to take on the lower price of oil as well. As of now, both countries have little incentive to concede on an agreement in the short-term and instead will likely compete on price to put pressure on each other.

As a result, our outlook for oil is relatively bleak with high volatility in the near-term, with Brent crude oil futures trading at roughly US$25.00 per barrel. But we do expect a recovery, possibly late in 2020 or early 2021 as demand for oil starts to pick up in the second half of 2020 as the virus crisis subsides and as OPEC+ members come to an agreement towards the end of 2020, somewhat resembling 2014's price war. Consolidation in the US shale oil industry will likely also help to keep oil prices above US$20.00 per barrel. Today’s release of the University of Michigan’s final estimate for its consumer sentiment survey will probably put some pressure of oil prices today, as the final estimate will likely consider consumer sentiment towards the end of March as well, when the number of confirmed cases of the virus surged.

Initial jobless claims surged last week as the confirmed number of cases of Covid-19 spikes in the US, signaling consumer sentiment for march will likely follow as well


Technical Analysis:         

Brent Crude Oil Futures

Brent crude oil dived after the OPEC+ meeting fell apart in early march. Bears took control as a result, managing to push the crude oil benchmark down below US$25 per barrel for a brief moment before oil bulls managed to push oil prices slightly higher thanks to multiple stimulus packages from the US. The Stochastic RSI indicator suggests that oil has not stepped into oversold territory yet, signalling that we may see oil prices continue to trend downwards today. With the final estimate for consumer sentiment in the US for March coming out later today, the bears may be able to push oil prices down lower to retest the US$25.10 support level as the index looks likely to disappoint as the number of coronavirus cases in the US surged towards the end of March.

Support: 25.10 / 24.00 / 23.00

Resistance: 28.34 / 30.64 / 32.47

Brent Crude Oil Futures Chart (4H)