Optimism seems to dominate global oil markets at the moment.
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, seemed unable to alter price assessments. Optimism stemming from OPEC + production cuts continues to dominate the market, with analysts happy to assume that the cartel will remain optimistic in its assessment of the second half of 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 its eighth consecutive week of earnings, and the market is happy with everything, but ignores the fundamentals.
Analysts seem convinced that the recovery in demand in the second half of 2021 is a certainty. If you asked what this assumption is based on, there would be no specific answer, but a reference to ‘feeling’. Biden’s recent announcement that Americans could have barbecues with their families on July 4th, that feeling is only growing. Additional financial support schemes around the world are adding to that sentiment. In fact, oil prices appear to be more closely linked to the injections of money that are being given around the world than to historical fundamentals. 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 while its revenue continues to fall. At the end of 2021, a major rebalancing in 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. The upward 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 schemes and a reduction in global blockages. If the optimistic predictions of a successful summer fight against the covid do not materialize, oil bulls will be slaughtered.
The current commodity frenzy has been largely fueled by institutional investors and hedge funds, all competing to reap the financial rewards of an overly optimistic market. Media reports have fueled this optimism as most investors prepare for the recovery in demand for crude oil. Fuel analysts are confident that the driving season in the US and Europe will raise prices, although 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. Furthermore, when looking at the future oil market, it seems that the optimism is not as strong as it seems at first. Net long vs. net short positions are almost at the same level. So even when it comes to optimistic sentiment, it seems that the media reports are exaggerating where we are.
When looking at current price settings, hovering around $ 70 a barrel, and quite a bullish sentiment among analysts, observers should be concerned. 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 realize their profits, then others will try to enter the market. The current supply-side stability is purely cosmetic. OPEC + unexpectedly decided to extend its existing agreements for another month. Saudi Arabia is still supporting its unilateral cut of 1 million bpd, while others are maintaining their existing commitments. Russia and Kazakhstan not belonging to OPEC were allowed to slightly increase their production.
All media reports were very positive about Vienna’s decision last week, portraying it as proof of the cartel’s internal stability. But that analysis fails to address 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 attractive level to increase production and money is needed across OPEC +. OPEC + producers lost trillions of dollars last year and now have the ability to make up for that loss.
At $ 70 a barrel, producers not controlled by OPEC + are also looking to increase production. Profit margins of $ 10-15 a barrel are too high for most producers to ignore. JP Morgan’s recent evaluation suggests that U.S. shale will put more production online soon. There are also reports that the actual OPEC + compliance rate differs from official quotas. Market analysts should keep an eye out for Saudi Arabia, the United Arab Emirates and Russia. It is likely that all three markets are already producing more oil than reported. Domestic demand for oil is also playing a key role in these countries, maintaining compliance. In Saudi Arabia, for example, Aramco’s most recent refinery project will account for 300-400 thousand barrels per day. Shale production in the US and Libya is certain to increase if price levels are kept around $ 70 or more. Greed is the blood of capitalism, and the oil and gas market has some of the most tempting profit margins at the moment.
While optimism may be dominating the market right now, the bearish sentiment may return to the oil markets 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 must be careful not to be overly optimistic when the fundamental equilibrium of the oil market remains decidedly delicate.
By Cyril Widdershoven for Oilprice.com