Optimism currently appears to rule global oil markets.
Even the recent OPEC report, in which the global oil group cut its demand forecasts for the second quarter of 2021 by more than 690,000 bpd, did not seem to change price estimates. Bullishness from OPEC + production cuts continues to dominate the market, and analysts expect the cartel to remain optimistic in its H2 2021 assessment.
With oil prices hovering around $ 70 a barrel and some analysts even suggesting the legendary $ 100 a barrel in sight, it seems all realism has been lost. Brent is poised for his eighth straight week of gains, and the market is happy to be close to ignoring fundamentals.
Analysts seem convinced that recovery in demand in the second half of 2021 is a certainty. If you were to ask them what that assumption is based on, there is no specific answer, but rather a reference to ‘sentiment’. Biden’s recent announcement that Americans could have BBQs with their families on July 4, that sentiment is only getting stronger. Additional financial support schemes around the world add to this sentiment. In fact, oil prices seem to be more closely related to the money injections being issued around the world than to historical fundamentals. But as we all know, “there is no such thing as a free lunch”. These financial injections will entail costs. No normal economy can continue to spend because income continues to decline. A major rescheduling of payments can be expected by the end of 2021 and there will be many losers. Demand is expected to decline slightly in the coming months, as highlighted in OPEC’s recent report. However, the bullish sentiment in the oil markets appears to be based on the post-summer period. Strong demand in the second half of the year will depend on successful COVID vaccination schedules and a decline in global lockdowns. If the optimistic predictions of a successful summer battle against covid don’t come true, oil bulls will be slaughtered.
The current commodity frenzy is largely fueled by institutional investors and hedge funds, all vying to reap the financial benefits of an overly optimistic market. Media reports have fueled this optimism as most investors prepare for a recovery in crude oil demand. Fuel analysts are convinced that the driving season in the US and Europe will increase prices, despite most vaccination projects being far from complete. With no real increase in journeys ahead, an increase in fuel demand seems far from certain. In addition, when looking at the oil futures market, the optimism does not seem as strong as it may seem at first glance. Net long positions versus net short positions are at almost the same level. So even when it comes to bullish sentiment, it seems that media reports are exaggerating where we are.
Looking at current price settings, hovering around $ 70 a barrel, and a lot of bullish sentiment among analysts, observers should be concerned. Price increases, as we have seen in recent months, in a normal situation (pre-COVID) always lead to two main reactions. First, the parties will take their profits, then others will try to enter the market. The current stability on the supply side is purely cosmetic. OPEC + unexpectedly decided to extend its existing agreements for another month. Saudi Arabia continues to support its unilateral cut of 1 million barrels per day, while others stick to their existing commitments. Non-OPEC producers Russia and Kazakhstan were allowed to slightly increase their production.
Media reports were all very positive about last week’s decision in Vienna, painting it as evidence of the cartel’s internal stability. But that analysis does not answer the growing internal pressure from major OPEC and non-OPEC producers to increase their own volumes in the coming weeks or months. $ 70 a barrel is a very tempting level to increase production, and cash is needed throughout OPEC +. OPEC + producers have lost trillions of dollars in the past year and now they can make up for that loss.
At $ 70 a barrel, producers not controlled by OPEC + are also trying to boost production. Profit margins of $ 10-15 a barrel are too high to be ignored by most producers. JP Morgan’s recent review suggests that American shale will soon bring more production online. There are also reports that the actual OPEC + compliance rate differs from the official quota. Market analysts should keep an eye on Saudi Arabia, UAE and Russia. All three markets are probably already producing more crude oil than reported. Internal crude oil demand also plays a key role in maintaining compliance in these countries. In Saudi Arabia, for example, Aramco’s latest refinery project will generate 300-400,000 barrels per day. Both US shale and Libyan production are sure to increase if the price level is held around $ 70 or above. Greed is the blood of capitalism, and the oil and gas market has one of the most enticing profit margins out there right now.
While optimism may rule the market at this point, bearish sentiment could flow back to the oil markets very soon. At current prices, supply will certainly increase, while demand is far from guaranteed. It is too early to call it a bear market, but observers should be wary of being overly optimistic when the fundamental equilibrium of the oil market remains decidedly delicate.
By Cyril Widdershoven for Oilprice.com