Optimism seems to be driving global oil markets at the moment.
Even the recent OPEC report, in which the global oil group reduced its demand forecasts for Q2 2021 by more than 690,000 bpd, seemed unable to change price estimates. The bullishness resulting from OPEC + production cuts continues to drive the market, with analysts excited to assume that the cartel will remain optimistic in its assessment of H2 2021.
With oil prices hovering around $ 70 a barrel and some analysts even suggesting that the fabulous $ 100 a barrel is in sight, it seems that all sense of realism has been lost. Brent is set for the eighth consecutive week of earnings, and the market is happy for everyone, but ignores the fundamentals.
Analysts seem convinced that the recovery in demand in H2 2021 is a certainty. If you ask them what this assumption is based on, there is no specific answer, but rather a reference to “feeling.” Biden’s recent announcement that Americans could make barbecues with their families on July 4, that the feeling is getting stronger. Additional financial support schemes around the world add to this sentiment. In fact, oil prices appear to be more closely linked to cash injections around the world than to historical foundations. However, as we all know, “there is no free lunch.” These financial injections will come at a cost. No normal economy can continue to spend as its income continues to decline. At the end of 2021, a major rebalancing of payments can be expected and there will be many losers. In the coming months, demand is expected to weaken slightly, as highlighted in the recent OPEC report. However, the bullish sentiment in the oil markets seems to be based on the post-summer period. Strong demand in the second half of the year will depend on successful COVID vaccination schemes and a decrease in global blockages. If optimistic predictions of a successful summer battle against covid are not met, oil bulls will be sacrificed.
The current commodity frenzy has been largely fueled by institutional investors and hedge funds, all struggling to reap the financial rewards of an over-optimistic market. Media reports have fueled this optimism, as most investors are preparing to recover the demand for crude oil. Fuel analysts are confident that the driving season in the US and Europe will raise prices, despite the fact that most vaccination projects are still far from complete. Without a real increase in travel on the horizon, an increase in fuel demand seems far from certain. In addition, when analyzing the oil futures market, it seems that optimism is not as strong as it first appears. Long net vs. short net positions are almost at the same level. So, even when it comes to the rising sentiment, it seems that media reports exaggerate where we are.
Observers should be concerned when looking at current price settings, which are around $ 70 a barrel and a lot of bullish sentiment among analysts. In a normal situation (pre-COVID), price increases as we have seen in recent months always lead to two main reactions. First, the parties will take their profits, then others will seek to enter the market. The current stability on the supply side is purely cosmetic. OPEC + has unexpectedly decided to extend the existing agreements for another month. Saudi Arabia continues to support its unilateral reduction of 1 million bpd, while others live up to their existing commitments. Non-OPEC producers, Russia and Kazakhstan, have been allowed to increase their production slightly.
The media reports were very positive about the Vienna decision last week, considering it as a proof of the internal stability of the cartel. But this analysis fails to address the growing domestic 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 attractive level for increasing production, and cash is needed throughout OPEC +. OPEC + producers have lost billions of dollars in the last year, and now they have the capacity to make up for that loss.
At $ 70 a barrel, producers who are not controlled by OPEC + are also looking to boost production. Profit margins of $ 10-15 per barrel are too high for most manufacturers to ignore. JP Morgan’s recent evaluation suggests that the American shale will soon bring more online production. There are also reports that the actual OPEC + compliance rate is different from official quotas. Market analysts should keep an eye on Saudi Arabia, the UAE and Russia. All three markets are likely to already produce more crude than reported. Domestic oil demand also plays a key role in maintaining compliance in these countries. In Saudi Arabia, for example, the latest Aramco refinery project will account for 300-400K barrels per day. Both US and Libyan shale production will certainly increase if price levels are maintained at around $ 70 or more. Greed is the blood of capitalism, and the oil and gas market has some of the most tempting profit margins right now.
While optimism could drive the market right now, bearish sentiment could soon return to the oil markets. 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 careful not to be overly optimistic when the fundamental balance of the oil market remains decisively delicate.
By Cyril Widdershoven for Oilprice.com