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Crude oil comment: Not so fragile yet. If it was it would have sold off more yesterday

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If the oil market was inherently bearishly fragile it should have sold off much more yesterday. Brent crude fell 1.5% yesterday to USD 69.28/b amid an overall very bearish market sentiment where the SPX index fell 2.7% amid increasing concerns for the damages Trump is doing to the US economy and the increasing risks for a US recession with Trump himself saying that a recession is possible but that in the longer-term everything will be better. Amid such an overall bearish market sentiment one could argue that the 1.5% decline in Brent crude yesterday was a fairly limited decline. Maybe because Brent has sold off so extensively since mid-January and thus has taken out a lot of downside action already. This morning Brent is up 0.3% to USD 69.5/b. Though still below the magical USD 70/b, but not much. If the oil market was inherently bearishly fragile it should have sold off much more yesterday.

A weakening of the 1-3mth time-spreads probably needed for Brent 1M to move lower. The 1-3mth time-spreads are holding quite steady. No rapid deterioration to be seen yet. And the flat price Brent 1mth contract is trading weakly versus the average 1-3mth time-spread of Brent, WTI and Dubai with Dubai the strongest. To see further aggressive downside price action, we probably need to see further deterioration in the front-end time-spreads.

A period of industry disruption ahead says US Energy secretary. The US Energy secretary Chris Wright has told the Financial Times that we’ll likely see a period of industry disruption ahead similar to the price war between OPEC and US shale oil producers in 2014. But that the US shale oil industry will come out stronger and with much lower costs than before. This is definitely not what the market is pricing in today. It can only take place if either OPEC+ or US shale oil producers boosts production or if we get a global recession. OPEC+ looks set for a controlled and gradual lifting of production and US shale oil players looks set for a very careful production growth. With such signals from Crish Wright one should think that US shale oil players will play an even more defensive game in fear of possibly tumbling prices. The signals from Crish Wright are chilling to say the least, but it is highly unclear how he is going to pull it off.

Brent 1mth has taken out the USD 68.68/b but has still not followed through to yet lower levels than the recent USD 68.33/b.

Brent 1mth has taken out the USD 68.68/b but has still not followed through to yet lower levels than the recent USD 68.33/b.
Source: Bloomberg

1-3mth time spreads of Brent, WTI and Dubai have recovered since mid-Feb and are holding out quite strongly. No deterioration to been seen at the moment.

1-3mth time spreads of Brent, WTI and Dubai have recovered since mid-Feb and are holding out quite strongly. No deterioration to been seen at the moment.
Source: SEB calculations and graph, Bloomberg data

The average 1-3mth time-spreads of Brent, WTI and Dubai versus the Brent 1mth contract.

The average 1-3mth time-spreads of Brent, WTI and Dubai versus the Brent 1mth contract.
Source: SEB calculations and graph, Bloomberg data

The average Brent 1mth price at current 1-3mth time-spreads at current level historically.

The average Brent 1mth price at current 1-3mth time-spreads at current level historically.
Source: SEB calculations and graph, Bloomberg data

Analys

June OPEC+ quota: Another triple increase or sticking to plan with +137 kb/d increase?

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Rebounding from the sub-60-line for a second time. Following a low of USD 59.3/b, the Brent July contract rebounded and closed up 1.8% at USD 62.13/b. This was the second test of the 60-line with the previous on 9 April when it traded to a low of USD 58.4/b. But yet again it defied a close below the 60-line. US ISM Manufacturing fell to 48.7 in April from 49 in March. It was still better than the feared 47.9 consensus. Other oil supportive elements for oil yesterday were signs that there are movements towards tariff negotiations between the US and China, US crude oil production in February was down 279 kb/d versus December and that production by OPEC+ was down 200 kb/d in April rather than up as expected by the market and planned by the group.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

All eyes on OPEC+ when they meet on Monday 5 May. What will they decide to do in June? Production declined by 200 kb/d in April (to 27.24 mb/d) rather than rising as the group had signaled and the market had expected. Half of it was Venezuela where Chevron reduced activity due to US sanctions. Report by Bloomberg here. Saudi Arabia added only 20 kb/d in April. The plan is for the group to lift production by 411 kb/d in May which is close to 3 times the monthly planned increases. But the actual increase will be much smaller if the previous quota offenders, Kazakhstan, Iraq and UAE restrain their production to compensate for previous offences.

The limited production increase from Saudi Arabia is confusing as it gives a flavor that the country deliberately aimed to support the price rather than to revive the planned supply. Recent statements from Saudi officials that the country is ready and able to sustain lower prices for an extended period instead is a message that reviving supply has priority versus the price.

OPEC+ will meet on Monday 5 May to decide what to do with production in June. The general expectation is that the group will lift quotas according to plans with 137 kb/d. But recent developments add a lot of uncertainty to what they will decide. Another triple quota increase as in May or none at all. Most likely they will stick to the original plan and decide lift by 137 kb/d in June.

US production surprised on the downside in February. Are prices starting to bite? US crude oil production fell sharply in January, but that is often quite normal due to winter hampering production. What was more surprising was that production only revived by 29 kb/d from January to February. Weekly data which are much more unreliable and approximate have indicated that production rebounded to 13.44 mb/d after the dip in January. The official February production of 13.159 mb/d is only 165 kb/d higher than the previous peak from November/December 2019. The US oil drilling rig count has however not change much since July last year and has been steady around 480 rigs in operation. Our bet is that the weaker than expected US production in February is mostly linked to weather and that it will converge to the weekly data in March and April.

Where is the new US shale oil price pain point? At USD 50/b or USD 65/b? The WTI price is now at USD 59.2/b and the average 13 to 24 mth forward WTI price has averaged USD 61.1/b over the past 30 days. The US oil industry has said that the average cost break even in US shale oil has increased from previous USD 50/b to now USD 65/b with that there is no free cashflow today for reinvestments if the WTI oil price is USD 50/b. Estimates from BNEF are however that the cost-break-even for US shale oil is from USD 40/b to US 60/b with a volume weighted average of around USD 50/b. The proof will be in the pudding. I.e. we will just have to wait and see where the new US shale oil ”price pain point” really is. At what price will we start to see US shale oil rig count starting to decline. We have not seen any decline yet. But if the WTI price stays sub-60, we should start to see a decline in the US rig count.

US crude oil production. Monthly and weekly production in kb/d.

US crude oil production. Monthly and weekly production in kb/d.
Source: SEB graph and highlights, Bloomberg data feed.
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Analys

Unusual strong bearish market conviction but OPEC+ market strategy is always a wildcard

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Brent crude falls with strong conviction that trade war will hurt demand for oil. Brent crude sold off 2.4% yesterday to USD 64.25/b along with rising concerns that the US trade war with China will soon start to visibly hurt oil demand or that it has already started to happen. Tariffs between the two are currently at 145% and 125% in the US and China respectively which implies a sharp decline in trade between the two if at all. This morning Brent crude (June contract) is trading down another 1.2% to USD 63.3/b. The June contract is rolling off today and a big question is how that will leave the shape of the Brent crude forward curve. Will the front-end backwardation in the curve evaporate further or will the July contract, now at USD 62.35/b, move up to where the June contract is today?

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

The unusual ”weird smile” of Brent forward curve implies unusual strong bearish conviction amid current prompt tightness. the The Brent crude oil forward curve has displayed a very unusual shape lately with front-end backwardation combined with deferred contango. Market pricing tightness today but weakness tomorrow. We have commented on this several times lately and Morgan Stanly highlighted how unusual historically this shape is. The reason why it is unusual is probably because markets in general have a hard time pricing a future which is very different from the present. Bearishness in the oil market when it is shifting from tight to soft balance usually comes creeping in at the front-end of the curve. A slight contango at the front-end in combination with an overall backwardated curve. Then this slight contango widens and in the end the whole curve flips to full contango. The current shape of the forward curve implies a very, very strong conviction by the market that softness and surplus is coming. A conviction so strong that it overrules the present tightness. This conviction flows from the fundamental understanding that ongoing trade war is bad for the global economy, for oil demand and for the oil price.

Will OPEC+ switch to cuts or will it leave balancing to a lower price driving US production lower? Add of course also in that OPEC+ has signaled that it will lift production more rapidly and is currently no longer in the mode of holding back to keep Brent at USD 75/b due to an internal quarrel over quotas. That stand can of course change from one day to the next. That is a very clear risk to the upside and oil consumers around should keep that in the back of their minds that this could happen. Though we are not utterly convinced of the imminent risk of this. Before such a pivot happens, Iraq and Kazakhstan probably have to prove that they can live up to their promised cuts. And that will take a few months. Also, OPEC+ might also like to see where the pain-point for US shale oil producers’ price-vise really is today. So far, we have seen no decline in the number of US oil drilling rigs in operation which have steadily been running at around 480 rigs.

With a surplus oil market on the horizon, OPEC+ will have to make a choice. How shale this coming surplus be resolved? Shall OPEC+ cut in order to balance the market or shall lower oil prices drive pain and lower production in the US which then will result in a balanced market? Maybe it is the first or maybe the latter. The group currently has a bloated surplus balance which it needs to slim down at some point. And maybe now is the time. Allowing the oil price to slide. Economic pain for US shale oil producers to rise and US oil production to fall in order to balance the market and make room OPEC+ to redeploy its previous cuts back into the market.

Surplus is not yet here. US oil inventories likely fell close to 2 mb last week. US API yesterday released indications that US crude and product inventories fell 1.8 mb last week with crude up 3.8 mb, gasoline down 3.1 mb and distillates down 2.5 mb. So, in terms of a crude oil contango market (= surplus and rising inventories) we have not yet moved to the point where US inventories are showing that the global oil market now indeed is in surplus. Though Chinese purchases to build stocks may have helped to keep the market tight. Indications that Saudi Arabia may lift June Official Selling Prices is a signal that the oil market may not be all that close to unraveling in surplus.

The low point of the Brent crude oil curve is shifting closer to present. A sign that the current front-end backwardation of the Brent crude oil curve is about to evaporate.

The low point of the Brent crude oil curve is shifting closer to present.
Source: Bloomberg graph and data, SEB highlights

Brent crude versus US Russel 2000 equity index. Is the equity market too optimistic or the oil market too bearish?

Brent crude versus US Russel 2000 equity index. Is the equity market too optimistic or the oil market too bearish?
Source: Bloomberg graph and data, SEB highlights

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Analys

Oil demand at risk as US consumers soon will face hard tariff-realities

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Muted sideways trading. Brent crude traded mostly sideways last week, but due to a relatively strong close on the Friday before, it ended the week down 1.6% at USD 66.87/b with a high-low range of USD 65.29 – 68.65/b. So muted price range action. Brent crude is trading marginally higher, up 0.3%, this morning amid mixed equity and commodity markets.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Strong Chinese buying in April as oil prices dipped. Chinese imports of crude continued to accelerate in April following a surge in March with data from Kepler indicating that Chinese imports averaged near 11 mb/d in April. That is an 18mth high and strongly up versus only 8.9 mb/d in January (FT.com today). That has most certainly helped to stem the rot in the oil price which bottomed at an intraday low of USD 58.4/b on 9 April. It has probably also helped to keep the front-end of the Brent crude oil forward curve in consistent backwardation. The strong buying from China is both opportunistic stockpiling due to the price slump but also rebuilding of oil inventories in general.

Oil speculators are cautious with oil demand at risk as US consumers soon will face hard tariff-realities. But oil market speculators are far from bullish. While net long speculative positions are up 52.2 mb over the week to last Tuesday, it is still only the 15th lowest speculative positioning over the past 52 weeks. The underlying concern is of course the US tariffs which is crippling exports of goods from China to the US with bookings of container freight down by 30% according to Hapag-Lloyd. Bloomberg’s Chief US economist, Anna Wong, is saying that empty shelves in US shops will soon be the reality. Thus US-China trade relations need to be fixed quickly to avoid hard realities for US consumers. The lead-times are long and the current tariffs and uncertainty around these is now risking availability for US consumer goods for the holiday seasons in H2-25. Tariff realities for US consumers are increasingly just around the corner.  ”Rubber will hit the road” very soon and that is when we might see weaker oil demand as well.

Brent crude traded mostly sideways last week though ended down 1.6% in the end.

Brent crude traded mostly sideways last week though ended down 1.6% in the end.
Source: Bloomberg graph and data

Net long speculative positions in Brent and WTI up 52.2 mb over week to last Tuesday but still at 15-week low over past 52 weeks.

Net long speculative positions in Brent and WTI up 52.2 mb over week to last Tuesday but still at 15-week low over past 52 weeks.
Source: SEB graph and calculations, Bloomberg data
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