Analysts’ Pick: Oil’s recovery is likely to be slow, but is there some room for it to drop in the short-term?
- Oil’s pace of recovery is likely to slow in the long-term thanks to the resurgence of Covid-19 infections.
- Global energy demand continues to be impacted by the pandemic, while China’s oil demand is likely to fall following the aftermath of the recent floods.
- OPEC+’s decision to taper off production cuts in August may as a result put some downward pressure on crude oil prices in the short-term as an inflow of oil is expected from both China and OPEC+ members.
- The upcoming fiscal stimulus package may put some upside pressure on crude oil prices, but it is likely to only be temporary.
Crude oil futures reached new post-lockdown highs since March earlier this week but returned most of its gains in the week after unemployment in the US appeared to be rising. While oil demand should continue to recover as countries and businesses continue to progress in dealing with the Covid-19 pandemic, we expect the pace for a recovery in oil prices to be slow. This is supported by market sentiment as well, with the contango flattening out as compared to roughly two months ago after WTI crude oil futures dipped into negative territory.
Brent crude oil futures curve suggests that the pace of recovery for crude oil prices is unlikely to reach that of what was seen in May and June
As before, a robust recovery in demand will need to be seen before we see oil track back closer towards pre-Covid-19 levels. Economic indicators suggest that the sharp economic rebound has mostly already played out in several of the large economies. This would mean that moving forward, demand is likely to pick up slower than before and only recover back to pre-Covid-19 levels if a vaccine for the novel coronavirus gets developed. The imbalance in containment of Covid-19 infections across the globe implies that a full recovery for oil is likely to be delayed as well. Higher frequency data in countries that have been more successful with containment of infections suggests that while there will be a quick rebound in economic activity, economic drivers are still likely to stay low as consumers will still be wary of an economic contraction and resurgence of Covid-19 cases.
A slow recovery in the transport sector remains a key hurdle for crude oil prices. Air travel demand continues to remain low, with airline companies acknowledging that they will need to scale back on flight schedules in August and September as the momentum that saw a spike in air travel demand following the lifting of Covid-19 lockdown restrictions fades.
Airline load factors across the world showed a sharp rebound in June after most countries came out of lockdowns, but the pace of recovery for airlines is likely to slow with US airlines announcing pullbacks in original flight schedules planned for August and September
The severe floods in China in July will likely negatively impact diesel and gasoline demand in the short-term as well. The floods will likely put pressure on China's refineries in addition to the pain that refiners are already feeling as a result of the contraction in demand for energy products as economic activity continues to recover slower-than-expected. Diesel stocks in Shandong increased to 7.5 million barrels in June, which is already above 2019's level of about 5.3 million barrels. With the impact of the floods likely to continue through to the end of July and potentially till mid-August, we expect diesel inventories in China to continue to rise and consequently diesel exports to rise as well.
June and May both saw a surplus in diesel inventories in Shandong refineries. July’s diesel stockpiles will likely be amplified further by the floods in China
OPEC+'s decision to continue with the tapering of production cuts starting from August will add additional pressure to crude oil prices as well. OPEC+ decided to taper its output limits to 7.7 million barrels a day from 9.7 million at its most recent meeting in mid-July citing signs of recovery in oil demand as its reason for the decision. But the recovery in oil demand that was seen as a result of multiple countries coming out of lockdown restrictions may not be sustained thanks to the resurgence in Covid-19 infections in multiple countries. While increased compliance among member countries provides a bright spot for the outlook of the coalition's agreement, the increased supply coupled with the already low demand will imply that oil prices will continue to trade at its current range, and possibly move lower before signs of recovery in both supply and demand markets.
Multiple large economies continue to experience accelerating new cases of Covid-19 infections
Official crude oil stockpile data in the US also provides several bearish signals with gasoline demand stalling while inventories continue to climb. The weekly report from the Energy Information Administration (EIA) for the week ended July 17th saw increased crude oil stockpiles in the US, along with an uptick in both gasoline and diesel inventories as well, implying that demand for both gasoline and diesel remains low.
Implied demand for diesel continues to remain low while demand for gasoline looks to be peaking following the lifting of lockdown restrictions in the US
Consequently, with demand likely to continue to continue to face downward pressure from a sustained slowdown in global economic activity and supply expected to increase in the coming weeks, there may be some room for oil prices to fall in the short-term and possibly see Brent active crude oil futures priced closer to 42.31. Over the medium-term we expect oil to continue to range at its current range (high 30s to low 40s, i.e. 39.00 to 45.00 per barrel) with little upside at its current price since it is unlikely that fundamentals will drive oil prices higher in a robust manner. Upticks should be expected with anticipation for the US government's upcoming fiscal stimulus measures, but it looks to only be temporary, similar to the impact from the EU's 750-billion-euro stimulus package this week as demand continues to be impacted by the Covid-19 pandemic and China's floods. In the long-term we do expect oil prices to recover closer towards pre-Covid-19 levels, but at a gradual pace before a vaccine can be produced and distributed.
Brent looks to be in a downtrend with no signs of stopping. MACD confirms that the benchmark is in downtrend while RSI signals that there is still much room to fall before reaching oversold levels. While the benchmark trades close to the uptrend support close to 42.96, bears may be able to put additional downward pressure on crude oil prices towards 42.31’s level. Bulls will likely try to retest the 38.2% Fibonacci retracement level and possible find a boost from the upcoming fiscal stimulus bill from the US government. It does look more likely that we will see a repeat of Brent’s performance when the EU passed its own fiscal stimulus bill earlier this week, but with slightly more volatility.
Support: 42.31 / 39.63 / 37.07
Resistance: 45.22 / 49.21 / 53.01
UKOIL Chart (H4)