Thursday, July 2, 2020

Is there more room for oil prices to rise as economic activity restarts across the world?

  • Oil
  • {$custom.WTI$}


Analysts’ Pick: Is there more room for oil prices to rise as economic activity restarts across the world?

  • Implied demand for gas, jet fuel and diesel look likely to recover, but remain at low levels in the short-term.
  • Oil rig counts in the US may rise following reactivations of shut-in rigs in Q3 2020, but looks likely to continue to decline in Q4 2020 in line with expectations for dampened economic conditions for the rest of the year.
  • Crude oil prices should as a result range near current levels, with most of its volatility from earlier this year easing.
  • The outlook for oil prices to recover over the longer-term should remain unchanged, but at a much slower pace than earlier anticipated.

Economic activity may be picking up in the US, but it looks to be a temporary recovery from the economy likely bottoming out in the middle of the year following Covid-19-lockdowns across the world. As a result, crude oil's recovery looks likely to be at a gradual pace moving forward, before the US and the global economy shifts into a robust economic recovery.

Manufacturing activity in the US signals that energy demand may be able to continue to recover in the US following easing of lockdown restrictions. ISM's PMI report for June looks somewhat promising, with the headline figure shifting into expansionary territory. Surprisingly, slow supplier deliveries as a result of the global supply disruption did not inflate the headline figure to a large extent, with the supplier deliveries sub-index falling to 56.9 from 68.0 in May. Manufacturing activity instead was driven by new orders and production, signalling that the US economy is benefitting from the easing of lockdown restrictions.

June’s headline PMI figure was driven by a surge in production and new orders unlike previous months which were largely inflated by slower supplier deliveries resulting from a disruption in the global supply chain



However, employment in the sector remained weak despite showing signs of recovery. The employment index rose to 42.1 from 32.1 in May, indicating that headcount continued to reduce but at a slower pace than before. This would imply that that employment is likely to remain mostly subdued while the US economy continues to recover at a more gradual pace. This will likely be reflected in the upcoming jobless benefits claims data, which will likely continue to decline at a slower pace than before.

A continued contraction in the transportation equipment industry signals that demand for fuel has yet to experience a robust recovery. This can also be confirmed by a weak recovery in the travel sector. Demand for travel has started to recover, but is currently still at extremely low levels. With the impact of the Covid-19 pandemic likely to last through the year, we expect the travel and leisure industry to continue to suffer. Demand for jet fuel will likely continue to remain weak as a result, impacting overall demand for crude oil. There may be some silver lining in the Covid-19 pandemic for gasoline prices though, since people are likely more inclined to increase spending on private transportation to avoid large crowds in public transportation, which should translate into some compensation for the waning demand in jet fuel. However, this is unlikely to be sustained through weak consumer spending and consumer confidence, and any increase in demand for gasoline is also unlikely to fully compensate the loss in demand for both diesel and jet fuel.

Bloomberg-calculated implied oil demand in China suggests a large spike in oil prices may have been driven by a restart in China’s economy after a sharp decline in economic activity in Q1 2020


The US Energy Information Administration's (EIA) weekly crude oil report for the week ended June 26th shows US crude stockpiles sharply declined, but confirms that the demand shock resulting from the Covid-19 pandemic is here to stay for an extended period of time. Implied demand for gasoline dipped for the week, possibly an after effect of renewed worries for another contraction in demand for gas prices due to an imbalance in Covid-19 infections across US states. California, Texas, South Carolina and Arizona are among the states that have been experiences an accelerating pace of new Covid-19 cases. The rapid acceleration in infections can be attributed to several factors. First, the increasing rate of testing now suggests that several states may have prematurely eased lockdown restrictions and is only now more accurately reflecting the rate of infections in those states. Secondly, ongoing protests against police brutality in the US has likely amplified the impact of premature lockdown easing. Already occurring is the impact of an imbalance in controlling the spread of Covid-19 infections in the US. California and Texas have halted their reopening, while states that have managed to keep Covid-19 infections under bay such as New York, have imposed restrictions for entering individuals from states that are experiencing rapid rates of infections to maintain the spread of the novel coronavirus. This implies that an economy recovery in the US may be more gradual than earlier anticipated. Concerns from both medical experts in the US and the Fed supports this as well, with Fed Chair Jerome Powell placing additional emphasis on controlling the spread of the virus to maintain an economic recovery for the US during his testimony to the House Financial Panel earlier this week. US oil prices may as a result experience a slower recovery as well, since multiple conditions skew the outlook for the US' economic recovery closer towards the downside.

Crude oil stockpiles sharply decline for the first time in three weeks in June helped calm financial markets on the swelling supply of crude oil in the US


Recovering implied demand of crude oil looks mostly driven by a recovery in demand for gasoline, while demand for diesel remains relatively low, signalling that the current recovery may only be temporary as it is due to unproductive economic activity


OPEC+'s output cuts continuing to be in force this month will likely help clamp down on the oversupply in crude oil markets. but a likely re-activation of shut-in oil rigs in June, July and possibly August in the US is likely to put downward pressure on demand for crude oil in the short-term, which in turn will weigh on crude oil prices. The shale oil industry still looks likely to continue to contract in Q4 2020 however, following potentially weak economic conditions through the rest of the year resulting from the Covid-19 pandemic.

Oil rig counts in the US usually lags the WTI benchmark, suggesting it is likely that we will see a resumption on shut-in oil rigs in Q3 2020


Declining open interest in WTI crude oil active contracts suggests that another rally spike is unlikely


Hence, our outlook for oil remains skewed to the upside in the long-term with an economic recovery post-pandemic crisis likely to help bring back demand for energy back to pre-Covid-19 levels. In the short-to-medium-term however, crude oil prices are highly unlikely to continue to recover at the pace seen before the pandemic. A drop in a similar manner to that from March to May is also highly unlikely unless the OPEC+ agreement breaks down (a downside risk for oil considering that the current agreement is more reliant on all members' compliance in comparison to previous deals). This suggests that oil is likely to continue to range at its current levels, with most of the volatility seen previously having eased over past weeks. In the case of the WTI benchmark, it may range between US$33.67 to US$44.19 per barrel in the short-to-medium-term, which continues to suggest a recovery trajectory, but at a much slower pace than before.

For crude oil prices to recover past the 40s level, a robust economic recovery cycle is likely needed, which should drive demand for the crude oil's end products much higher than current levels and closer to pre-Covid-19 levels. This implicitly means that moving forward, demand should be the main driver for crude oil prices in the long-term. Risks to the outlook includes a breakdown in OPEC+'s production limit agreement, which may be a greater one than anticipated as oil producing countries suffer the impact of low oil prices, low export volumes and a global economic contraction amid the Covid-19 pandemic. Other risks include unexpected spikes in supply for oil due to unaccounted for crude oil that oil traders may still be holding on to via floating storages.

Technical Analysis:


Bulls appear to be losing steam after almost a two-month long rally out of crash in oil prices seen at the end of May. The upward trend looks likely to remain, but at a much slower pace than before as the WTI benchmark nears the 200-day moving average. With the benchmark trading just above the 20-day moving average in the Bollinger bands, there may be some room for a decline closer towards 38.00 as a result of possible profit taking before recovering back above the 20-day moving average. In the medium-term we expect the WTI crude oil to range at current levels. However, the 50% Fibonacci may be a strong enough support to sustain a range between 44.19 and 37.63 as oil prices continue its upwards trajectory.

Support: 38.77 / 37.08 / 34.67

Resistance: 41.12 / 42.50 / 44.19

USOIL Chart (H4)