After an yo-yo movement in crude oil market last three weeks, including negative prices for the US-centric WTI (West Texas Intermediate), there is now a noticeable shift in the sentiment with prices rising smartly in a short span of time. Obviously, the extreme stress witnessed in April has eased markedly.
It is of course unclear at this point in time if the worst is over for the oil market. Currently, both supply side and demand side factors are at play.
Price recovery
From its low of sub-$20 a barrel, Brent has quickly risen to test $30, while WTI has shown a smart recovery, trailing Brent by $5-6 a barrel. If anything, rates for the forward months are higher. With early signs of price recovery, speculative capital has moved into this market.
It is not the case that the market participants have forgotten the nightmarish scenario of storage installations brimming over on the one hand and widespread demand destruction on the other, in the wake of the Covid-19 pandemic. But it is in the very nature of the commodity market that participants constantly look at possible changes in the supply-demand fundamentals at a forward point in time.
Cut in production
On the supply side, the OPEC+ decision to cut production has kicked in. Many companies have scaled back production. Major shale oil producers in the US have announced production cuts, and have stopped drilling and fracking. Exploration is all but stopped.
The rig count has been declining week-on-week and is currently estimated at 325 as of May 1 versus 468 as of April 18. Shale production has fallen below the psychological 12 million barrels a day in the US as compared with over 13 mbd in March. With the US producers scaling back output, the spread between Brent and WTI is likely to narrow.
But there is also the real likelihood that some producers may be tempted to resume production if they see WTI stay above $25 or Brent above $30 a barrel for a period of time.
Positive outlook
However, with lockdowns appearing to be past their peak in several countries and activities in China picking up momentum fast, demand side concerns have eased. It would surely take two to three months for industrial and trade activities across the world to make a comeback. So, demand outlook is gradually turning positive.
But the big suspense is over the extent to which demand will pick up in the coming months. The market at the moment seems to be optimistic about demand prospects as lockdown restrictions begin to ease and economic activities spring to life. China’s import data will be watched closely.
Given the current supply-demand fundamentals and uncertainties associated with demand growth, it may take several months for the market to set the burdensome inventory lower. Success of the coronavirus containment measures will be keenly tracked.
Volatility
So, it is reasonable to believe that oil prices will remain low (Brent hovering in the $25-30 a barrel range) over the next 3-4 months. It is no time to celebrate though. If restrictions are lifted too soon, there is the risk of recurrence of the pandemic. In other words, the oil market will continue to remain volatile.
(The writer is a policy commentator and commodities market specialist. Views are personal)