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Oil: a slippery slope

02 October 2020

5 minute read

By Jai Lakhani, London UK, Investment Strategist

Economies reopening, sentiment improving and positive supply cut news has been a tailwind for oil over the past three months. However, risks of another round of COVID-19 infections and a more prolonged period of recovery than many investors expected may alter the paradigm once more.

The oil market made progress towards recovery in July and August as supply cuts and better than expected economic activity stabilised futures curves while Brent crude topped $40 per barrel.

However, a sustained recovery was always going to hinge on COVID-19 infection rates. Cases are spiking globally, impacting sentiment and increasing the risk of fresh containment measures.

Demand weakens

International Energy Agency (IEA) data shows that global demand fell by 10.5m barrels per day (bpd) between January and July compared to last year. In addition to local quarantine measures and increased teleworking, cautious consumer sentiment has contributed to the aviation sector (a key sector for oil) remaining weak.

These factors have more than offset any uplift from increases in personal mobility data as a result of social distancing. India is a major importer of oil and has continued to see an exponential increase in cases. Indeed, August’s month-on-month growth in oil demand was the weakest since April.

The hit to demand is crucial in determining the commodity’s fate, with September showing Brent crude failing to make further inroads towards a balanced market. What’s more, Chinese crude buying has slowed sharply in September and October, with unsold barrels now starting to pile up. According to the IEA, this combined with weak refinery margins has meant that inventories are building, with trading houses looking for charter ships in which to store oil.

OPEC production cuts

OPEC+, a group comprising members of the Organization of the Petroleum Exporting Countries (OPEC) and other leading oil producers, agreed to cut production by 9.7mbpd in May and June. Cuts of 7.7mbpd are also in place until the end of the year.

Providing some further support to the oil price has been hurricane Laura in the US. Laura forced precautionary shut-ins and lowered production by 0.4mbpd in August, with a tepid September recovery likely due to hurricane season in the Gulf of Mexico and low American rig counts.

However, despite this, the reduction has failed to meet the sheer magnitude of the demand-side fall. OPEC argues in its monthly report that the pandemic has reduced 2020 demand by a staggering 9.5mbpd.

COVID-19 is key to unlocking a balanced market

The economic impact of the coronavirus and oil prices across industries like aviation, transportation and tankers will ultimately be determined by the lifespan, intensity and geographic spread of the virus.

While cases are rising at an alarming rate (particularly in Europe), this does not necessarily signal a return to national lockdowns due to the devastating effect that such measures have on economic output. It is worth noting that the recent rise in cases is less pronounced than the initial spike, healthcare systems appear well versed in treating and managing patients and the public are more susceptible to changing social interactions.

Ultimately, we expect oil prices to be range-bound in the near term as supply cuts partially counter the fall in demand. As producers, businesses and citizens adapt to the new world, some activities will take time to fully normalise, such as air travel. Furthermore, the oil price has likely passed its initial fast pace of recovery.

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Market Perspectives October 2020

Financial market sentiment has taken a turn for the worse as COVID-19 infection numbers climb and the US presidential election nears.

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