Friday, June 12, 2020

Is there more room for crude oil to fall following a 9.86% drop week-to-date?

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  • Oil
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Analysts’ Pick: Is there more room for crude oil to fall following a 9.86% drop week-to-date?

  • The outlook for oil prices remains tilted to the upside as downside risks remain relatively limited.
  • In the short-term oil prices may have more room to drop, but is unlikely to reach levels seen in the first half of May.
  • Oil’s recovery however, is likely to be at a slower pace than before, as recovery in the airline industry is more likely to be slow as a recovery in domestic travel is unlikely to outweigh a slow pick up in international travel.

Crude oil futures suffered yet another rout on Thursday after a strong rally brought the WTI crude oil benchmark up 62.43% in May. But fundamentals still point to a higher likelihood of oil prices recovering over the medium-to-long-term, albeit at a slower pace than what was seen in May.

OPEC+'s production limit extension should help to limit the ongoing oversupply in crude oil markets. OPEC+ members agreed to extend output cuts of 9.6 million barrels per day (bpd) up until July over the weekend. While voluntary cuts are likely to not be extended into July, the extension of production cuts is a signal that oil prices were still too low for OPEC+ members. This is likely since at the current price of oil, there is little room for a number of OPEC+ members to be able to balance their fiscal budgets. Also, an additional term was written into an agreement regarding compliance of OPEC+ members. The statement implied that OPEC+ members that were unable to meet the output limit set for May and June were to compensate for it in the coming months. While it does signal that overall output limits for July may total more than 9.6million bpd, it also introduces an additional risk since the new detail implicitly puts more emphasis for future agreements on members compliance.

In terms of sentiment for crude oil, the steep contango seen during April and May has flatten largely. While the futures curve still implies that the longer-term outlook for oil prices still remain mostly similar. This means that short-term profits from crude oil has likely eased. The flattening of the contango seen earlier is likely due to OPEC+'s output cuts, as well as improving sentiment for a recovery in energy demand as economies start to reopen.

The steep contango seen in May has flattened over the past month as the outlook for oil in the short-term recovers

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Demand for jet fuel is likely to weigh on oil prices the most, since airlines are unlikely to return to full capacity in the short-term. With Covid-19 still being a strong factor against air travel, demand for non-essential flights will probably remain low. While pressure on jet fuel demand will likely be eased by a recovery in domestic flights across the world, international travel will remain largely under distress since countries across the world are recovering from the Covid-19 pandemic at different rates. Adding to this, a potential spike in Covid-19 infections will likely impact international travel more as compared to domestic travel, and hence is likely to still put downside pressure on crude oil prices.

Multiple countries across the world are still dealing with increasingly more Covid-19 confirmed cases, implying that rates of recovery will vary across the world

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While the US’s overall count of new cases of Covid-19 infections has somewhat slowed, multiple cities have reported a spike in new cases over the past few days

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Gasoline prices are likely to be the opposite, with the spread between gasoline future contracts implying that sentiment is still skewed to a recovering in gas prices in the short-term. With gas prices expected to rise, refineries should start to restart production since margins will start to widen. Crude oil's prices should thus be positively impacted by an expected increase in oil prices moving forward. The sentiment surrounding gasoline prices should also be justified since downside risks for gasoline prices are likely limited, since lockdown restrictions will more likely ease as opposed to revert back to a nationwide-lockdown for most countries.

A positive spread between the August and July gasoline futures suggests that sentiment still expects demand to continue to recover

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Finally, downside risks for oil demand is likely relatively limited across the world since economic activity across the world has not recovered fully from the effects of the Covid-19 pandemic. While demand should remain subdued in the short-term, a recovery in energy demand is likely to outweigh the potential downside if risks such as a spike in Covid-19 cases surface. As such, a recovery should still be expected for oil prices, but at a much slower pace than before. Higher volatility in oil prices should also be considered however. Momentum may be able to pull WTI crude futures lower towards US$31.16's level in the near-term but a drop below US$30 per barrel looks unlikely. OPEC+ cuts and a probable recovery in oil prices should be able to support prices, back closer towards US$40.06's level in the short-term.

Technical Analysis:

USOIL

The US crude oil benchmark has broken below the 50-day EMA line as concerns on a potential second wave of Covid-19 infections and the plummet in US equities fuelled a selloff in oil markets. Bears will likely try to retest the 34.37 support line and looks likely to break that level and trend closer towards the stronger resistance at 31.16’s level. While bulls may not be able to gain momentum in the shorter-term, the medium-to-longer-term prospects for oil prices still looks to be favourable. As the benchmark trends closer to the 14-day RSI oversold levels, bulls are likely to take over control of the index. But, a recovery back to the most recent high of above US$40.00 per barrel may not be in the near-future.

Support: 34.37 / 31.16 / 27.40

Resistance: 36.53 / 38.45 / 40.06

USOIL Chart (H4)

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