SINGAPORE (June 4): As markets begin to reopen from Covid-19 lockdowns, demand for crude oil has rallied ahead of expectations. Brent crude oil prices stood at US$39 ($54.64) per barrel at the time of writing, which is more than double recent lows of around US$19 a barrel recorded at the end of April. 

“Demand destruction due to the COVID-19 pandemic response did peak in April as we had expected, but easing of lockdown restrictions in some parts of the world ahead of the infection rates peaking out has meant that oil demand recovery could be faster than we had earlier anticipated,” say DBS analysts Suvro Sakar, Jason Sum, and Ho Pei Hwa. Oil production cuts by approximately 15.0 mmbpd m-o-m have also eased pressure on oil storage facilities. 

The analysts have revised global oil demand projections upwards from a decline of 11.0mmbpd  to a decline of 9.0mmbpd in 2020, with supplies expected to fall around 7.0mmbpd. These predictions have accounted for production cuts by OPEC+ as well as large non-OPEC producers like the US and Canada, with demand-supply balance expected for end of 3Q20. 

Hopes of demand revival aside, stronger liquidity in general equity and risky asset markets and signs of better supply-side discipline from Saudi and Gulf allies have fuelled optimism in oil markets. “While there might be an odd pullback or two, we expect upward momentum to be maintained in general for the rest of the year, with Brent exiting 2020 above US$50 a barrel,” say the analysts. They have raised their crude price predictions from US$37-42 a barrel to US$42-47 a barrel for 2020 while maintaining 2021 forecasts at  US$55-60 a barrel. 

Inventory overhang from the wide supply-demand gap in 2020 will serve as the key moderating factor for crude oil prices in 2021, with the analysts observing that lower inventories would have led to a sharper price recovery. Questions also remain regarding the speed with which US shale production will recover from a steep 1.5mmbpd decline from February 2020 levels amid rising crude prices, which could affect the resolve of OPEC+ to cut production going forward.  

“According to estimates, a majority of Drilled and Uncompleted Wells (DUCs) should be profitable at WTI [West Texas Intermediate] more than US$25 a barrel. Hence, with WTI at more than US$35 a barrel currently, some US shale producers may be thinking of more well completions or even drilling new wells soon,” report the analysts. This would further increase oil supplies while simultaneously affecting the earnings of crude producers, and possibly tempting some to increase production again.  

Though OPEC+ is due to meet again from 9-10 June, the meetings may be brought forward to Thursday and Friday this week to allow key producers to better manage future export nominations for long-term clients. The meeting is expected to discuss whether to extend current production cuts of around 10mmbpd by another two months. Negotiations between Russia and Saudi Arabia will be in the spotlight -- Moscow remains undecided about pursuing the cuts further, with Russia’s largest producer Rosneft allegedly facing difficulty in keeping to its quotas.

Sakar, Sum and Ho do not expect much positive surprises from the pow-wow, believing that the market has already priced-in most of the expected gains from the meeting. If anything, they warn that investors may be disappointed if OPEC+ chooses to maintain its original production cuts schedule without rolling over higher levels of such cuts. Compliance with the agreed cuts has also been challenging, with the compliance rate for May standing at only 74%, with Iraq and Nigeria are the main culprits. It remains to be seen if this “cheating” proves a source of tension. 

While the DBS analysts are less optimistic than most financial market observers about China’s resolve to pass its controversial new National Security Law on Hong Kong, they do not see this having an unduly severe impact on Hong Kong’s prospects. Even if the US revokes special privileges for the city, Hong Kong-US trade had long been trending downwards due to the opening up of China’s coastal cities and the shift in value-added manufacturing to Southern China. They nonetheless expect worsened terms of trade and higher administrative costs.  

“Overall, we see US-China tensions intensification to have some impact on global trade and therefore oil demand, but it may not be material relative to the demand destruction caused already by COVID-19 that is likely to persist in some quantum at least till the end of 2021,” they report, noting that oil demand is unlikely to return to pre-Covid levels till 2022. 

Risk to oil prices in the near-term arising from geopolitical and trade disputes is therefore likely to stem more from investor sentiment and liquidity rather than demand-supply fundamentals. While a risk off situation from US-China tensions could affect equity and oil markets in the near future, both are currently behaving optimistically. These risks are unlikely to unduly undermine the price rally in crude oil prices as the market looks to restore demand-supply balance.  

As of 1.42pm today, Brent crude oil is trading at US$39.24 a barrel while WTI is going at US$36.48 a barrel.