Commodities

The oil market finds its balance

Oil

Signs that oil supply and demand are moving into balance as the world emerges from the pandemic mean that we are revising upward our year-end price target for the price of Brent.

Developments on the covid-19 front have been one the major factors underpinning investor sentiment since the 21 April nadir for oil prices, ensuring the Brent oil price increased by from a low of USD17 on 21 April to USD44 per barrel in early July.

 

 The decline in new cases of the virus, notably in European countries, has reinforced hopes that the pandemic is under control, sparking a lifting of lockdown measures…and a recovery in oil prices. High-frequency data such as mobility data collected from cell phones allow us to track the path back to normality in real time. The data has been relatively reassuring, nurturing hopes that economies are recovering rapidly after the end of lockdown measures. This rapid recovery in mobility and changes in travel habits (a preference for individual means of transport over mass transit) means higher demand for refined products despite ongoing weakness in air traffic.

 

In the US, demand for motor gasoline has rebounded from -41% of its 2015-2019 average in April to -11% in June. This shift in habits has helped to support crude demand as refined products constitute a large part of oil demand (gasoline accounts for 36% of total oil demand and diesel 26%) and has helped compensate for the plunge in demand for air fuel (10% of total demand).

 

The historical collapse in demand has forced producers to react decisively. First, on 12 April OPEC, in conjunction with Russia and other non-OPEC members, announced a huge 9.7mbd reduction in production in May and June with production to be 7.7mbd lower for the rest of the year, followed by a 5.8mbd reduction in 2021. Given the success of the operation (the Brent price jumped from USD17 on 21 April to USD42 in early June), the OPEC+ decided to extend the 9.7mbd cut to July. Overall, disciplined supply cuts by OPEC and non-OPEC producers alike mean that supply and demand already found a balance in June.

 

The 5% weakening of the dollar (in real trade-weighted terms) since the end of March has already had a significant impact on our estimate of the fundamental long-term equilibrium oil price, which has shifted from USD18 to USD23. The equilibrium price rises to USD32 once our central scenario that the US dollar will weaken for the rest of the year is taken into account.

 

A higher long-term fundamental equilibrium price combined with encouraging signs of economic recovery (despite the recent increase in new covid-19 cases) and restraints on supply (whether voluntary or not) point to a higher oil price.  As a result, while we are conscious that supply could rapidly increase again and thus limit price potential, we are adjusting our end-of-year Brent price forecast to USD40.

 

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