At the moment, optimism seems to be dominating global oil markets.
Even the recent OPEC report, in which the global oil group cut its forecasts for the second quarter of 2021 by more than 690 000 bpd, could not change the price estimates. The ominousness of OPEC +’s production cuts continues to dominate the market, and analysts like to assume that the cartel will remain optimistic in its assessment of H2 2021.
While oil prices are around $ 70 a barrel and some analysts even suggest that the factory value of $ 100 a barrel is within sight, all sense of realism seems to have been lost. Brent plans to make its eighth consecutive week of profit, and the market is happy to ignore the fundamental aspects.
Analysts appear to be convinced that the recovery in demand in H2 2021 is a certainty. If you were to ask them what the assumption is based on, there is no specific answer, but rather a reference to ‘sentiment’. Biden’s recent announcement that Americans would be able to braai with their families on July 4 is that sentiment is only getting stronger. Additional financial support schemes around the world are contributing to this sentiment. In fact, oil prices seem to be more closely linked to the cash injections issued worldwide than to historical principles. However, as we all know, there is no such thing as a free lunch. These financial injections are going to be expensive. No normal economy can continue to spend as its income continues to decline. By the end of 2021, a major rebalance in payments can be expected, and there will be many losers. In the coming months, demand is expected to weaken slightly, as highlighted in OPEC’s recent report. However, the strong sentiment in the oil markets looks set for the period after summer. The strong demand in the second half of the year will depend on successful vaccination schemes for COVID and a decrease in global barriers. If the optimistic predictions of a successful summer fight against covid do not come true, oil bulls will be slaughtered.
The current commodity swing is largely fueled by institutional investors and hedge funds, all of whom want to reap the financial rewards of an overly optimistic market. Media reports fueled this optimism as most investors prepare for the recovery in crude oil demand. Fuel analysts are confident that the management season in the US and Europe will increase prices, despite the fact that most vaccination projects are far from complete. With no real increase on the horizon, an increase in fuel demand appears to have been decided. Looking at the oil futures market, it also seems that optimism is not as strong as it first appears. Net long versus net short positions are at almost the same level. So, even when it comes to bullish sentiment, it seems that media reports are exaggerating where we are.
Looking at current price settings, with about $ 70 a barrel and very strong 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, parties will take their profits, then others will look to enter the market. The current stability on the supply side is purely cosmetic. OPEC + unexpectedly decided to carry over its existing agreements for another month. Saudi Arabia continues to support its unilateral cut of 1 million bpd, while others meet their existing commitments. Non-OPEC producers Russia and Kazakhstan have allowed their production to increase slightly.
Media reports were all very positive about the decision last week in Vienna, and this is a testament to the internal stability of the cartel. But the analysis does not 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 cash is needed throughout OPEC +. OPEC + producers have lost trillions of dollars over the past year and now have the ability to make up the loss.
At $ 70 a barrel, producers not controlled by OPEC + also want to increase production. Profit margins of $ 10-15 per barrel are too high for most producers to ignore. JP Morgan’s recent assessment suggests that US shale will soon bring more production online. There are also reports that the actual OPEC + compliance rate differs from the official quotas. Market analysts need to keep an eye on Saudi Arabia, the UAE and Russia. It is likely that all three markets are already producing more crude than reported. The internal demand for crude oil also plays a key role in these countries maintaining its compliance. In Saudi Arabia, for example, Aramco’s latest refinery project will cover 300-400K barrels per day. Both US shales and Libyan production will definitely increase if price levels are kept at around $ 70 or higher. Greed is the blood of capitalism, and the oil and gas market currently has the most attractive profit margins.
Although optimism may currently dominate the market, a bearish sentiment may soon flow back into the oil markets. At current prices, supply will surely increase, while demand is far from guaranteed. It is too early to call it a bear market, but observers need to be careful not to be too optimistic if the fundamental balance of the oil market remains delicate.
By Cyril Widdershoven for Oilprice.com