Right now it seems that optimism is ruling the world oil markets.
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 valuations. The upward trend stemming from OPEC + production cuts continues to dominate the market, with analysts happy to assume that the cartel will remain optimistic in its H2 2021 assessment.
With oil prices around $ 70 a barrel and some analysts even suggest that the famous $ 100 a barrel is in sight, it seems like all sense of realism has been lost. Brent is slated for its eighth consecutive week of earnings and the market is happy with 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 a reference to “feeling”. Biden’s recent announcement that Americans could have barbecues with their families on July 4, that sentiment is only getting stronger. To this sentiment are added additional financial support systems around the world. In fact, oil prices appear to be more tied to the cash injections that are being given to 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. By the end of 2021, a significant rebalancing in payments can be expected and there will be many losers. Demand is expected to weaken slightly in the coming months, as highlighted in the recent OPEC report. Upward sentiment in oil markets appears, however, based on the post-summer period. Strong demand in the second half of the year will depend on the success of COVID vaccination schemes and the reduction of global blockades. If optimistic predictions of a summer fight against covid are not fulfilled, oil oxen are expected to be slaughtered.
The current frenzy of commodities has been fueled largely by institutional investors and hedge funds, which compete to reap the financial benefits of an overly optimistic market. Media reports have fueled this optimism, as most investors are preparing to recover crude demand. Fuel analysts are confident that the driving season in the U.S. and Europe will raise prices even though most vaccination projects are still far from over. Without a real increase in travel on the horizon, it seems that an increase in fuel demand is not true. Also, when looking at the oil futures market, it seems that optimism is not as strong as it first seems. Net long and short net positions are almost at the same level. So even when it comes to bullish sentiment, it seems that media reports are exaggerating where we are.
When looking at the current price setting, which is around $ 70 a barrel and a strong bullish sentiment among analysts, observers should be concerned. In a normal (pre-COVID) situation, price increases as we have seen in recent months always lead to two main reactions. First, the parties will take their profits and then others will seek to enter the market. The current stability in terms of supply is purely cosmetic. OPEC + unexpectedly decided to extend its existing agreements for another month. Saudi Arabia continues to support its unilateral reduction of one million bpd, while others maintain their existing commitments. Russia and Kazakhstan, which were not OPEC producers, were allowed to slightly increase their production.
Media reports have been very positive about Vienna’s decision last week, which saw it as a test of the cartel’s internal stability. But this analysis fails to cope with the growing internal pressure from major OPEC producers 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 lost billions of dollars last year and now have the capacity to make up for that loss.
At $ 70 a barrel, non-OPEC + producers are also looking to increase production. Profit margins of $ 10-15 per barrel are too high for most producers to ignore. From JP Morgan recent evaluation suggests that the American shale will bring more online production soon. There are also reports that the actual OPEC + compliance rate is different from official quotas. Market analysts should monitor Saudi Arabia, the United Arab Emirates and Russia. It is likely that all three markets will already produce more crude than is reported. Domestic demand for crude oil is also playing a key role in maintaining compliance in these countries. In Saudi Arabia, for example, Aramco’s latest refinery project will account for 300-400K barrels per day. It is certain that both US and Libyan shale production will increase if price levels remain around $ 70 or more. Greed is the blood of capitalism and the oil and gas market has some of the most tempting profit margins out there right now.
While optimism rules the market right now, bearish sentiment could flood the oil markets again very soon. 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 should be wary of being too optimistic when the fundamental balance sheet of the oil market is decidedly delicate.
By Cyril Widdershoven for Oilprice.com