“Exuberance” is now the word of the week in oil market news. According to the Wall Street Journal on Monday, “oil’s future looks bright.”
That’s remarkable, because just a few weeks ago, other publications said the oil industry was a “nightmare,” its future was “uncertain” and the market was in deep “turmoil.”
Both Brent and WTI have been on an upward trajectory since May 13, though this week’s gains are not as sharply positive as last week’s.
However, it’s important to remember that even though WTI has gained $23 and Brent $15 in the past 30 days, both benchmarks are still priced in the $30s. While $30 oil is better than $10 or $20 oil, and this change looks significant on a chart, the reality is that sub-$50 prices are unsustainable for most U.S. shale producers and sub-$40 prices are troublesome for the world’s second largest oil producer, Russia.
There are real signs that oil production is declining and some indications that oil demand is rising, but it seems that sentiment, hope and headlines are still driving much of the recent price movement. But sentiment alone can be fickle. Let’s break this down:
Supply
Oil production is down across the globe, but signs are mixed as to whether it will stay low or even continue to decline into the second half of 2020.
Gulf oil producers like Saudi Arabia, Kuwait and UAE all implemented their promised cuts in May and have committed to take even more oil off the market—as much as 1.2 million bpd—in June.
However, the biggest positive surprise has been Russia. After years of failing to fulfill its promised production cuts, data indicate that Russian oil production has dropped dramatically in May. According to Reuters, Russia produced 9.42 million bpd of oil between May 1 and May 19 (including gas condensate). Exempting gas condensate, which is not counted in Russia’s official quota according to Russia’s deal with OPEC+, production is at 8.72 million bpd. This is only 320,000 bpd over Russia’s quota, which is surprisingly good for Russia.
Production in the United States has also continued to fall. The EIA estimated that production for the week ending May 15 was down to 11.5 million bpd and the number of active oil and gas rigs in the United States is the lowest since the EIA started keeping records in 1987.
These production cuts have fueled the recent rise in oil prices, but there are signs that supply could start to grow again in the near-term. Alyeska Pipeline (the company that operates the Trans-Alaskan Pipeline) controls all of the production in Alaska, and it just decided to reduce its pro-rationing plans. Back in April, Aleyeska announced it would slash North Slope oil production by 10%, but it has now decided to reduce only 5%.
Some U.S. oil producers in the shale oil region have indicated that they are ready to increase production when prices reach a certain threshold. Diamondback (NASDAQ:FANG) and Parsley Energy (NYSE:PE) said that once WTI hit $30 per barrel, they would start to consider raising production and even opening new wells. WTI is now more than $30.
When it comes to OPEC+, Iraq and Kazakhstan have yet to comply with their agreed-upon production cuts. Iraq, in particular, has slashed less than 200,000 bpd out of the 1 million bpd. These countries have to negotiate cuts with IOCs that operate certain oil fields, so the process is not streamlined as it is in Saudi Arabia or UAE. It is likely that Iraq and Kazakhstan will simply drag their feet on cutting production to take advantage of the slightly higher prices and bring in as much revenue as possible.
Demand
As economies start to re-open for business, oil demand is picking up. According to GasBuddy, which tracks gasoline use in the United States, gasoline demand is slowly climbing from lows in the beginning of April. Gasoline demand is still almost 20% lower than it was in the second week of March and is 25% lower than it was in May 2019, but it is growing incrementally.
The most significant indicator of rising oil demand comes from China. Chinese oil demand is back up to 13 million bpd, according to reports from Bloomberg. In February, China's oil demand was reportedly down by 20% due to closures from the coronavirus. There are some indications that gasoline demand will rebound to levels that are higher than before the outbreak. The TomTom Traffic Index shows that traffic congestion in Beijing is higher than usual, which could be due to a greater number of cars on the road as people opt to drive rather than utilize public transportation.
It’s possible that we will see this trend in other cities as well, although it is too early to know. It is increasingly likely that in places like London and New York workers will not return to offices and commuters will be forced to use bicycles or walk.
Sentiment
The data showing that oil demand is increasing are more tenuous than the data showing that oil production is declining. However, oil prices—like equities—are heavily influenced by sentiment (fueled in large part by news headlines). There seems to be a growing sentiment this week that things are getting better as economies open, but that's this week.
Movement and business in many major cities are still locked down and air travel remains seriously depressed, even in regions where there are no longer restrictions. We do not know how fear of a virus will impact economic activity after the remaining lockdowns end. In addition, the decline in global GDP will weigh heavily on oil demand even when travel and commercial restrictions are lifted. As a result, there are still too many unknowns about the future of demand.