Worst is Over for the Oil Market

• Crude oil markets looked to have stabilised as sharp reductions in output have come amid a rebound in demand

   

• 12-month Brent crude price forecast is unchanged at $45/bbl but we raised the 3 and 6-month forecasts to $36/bbl (old: $30) and $40/bbl (old: $38) respectively

   

• OPEC disunity and signs of US oil production returning are set to slow the climb in oil prices

Oil markets staged a spectacular recovery after the WTI oil futures contract was treated like garbage in April. The negative futures oil price for the May delivery has meant that traders had to pay to have it taken off their hands, in much the same way we pay to get rid of garbage.

Crude oil markets looked to have stabilised

^{Source: Bloomberg, Bank of Singapore}

The easing of lockdown measures and steep production declines in non-OPEC countries along with OPEC+ lends hope that the worst is over for the oil market. The collapse in supply and partial demand rebound should be enough to move oil markets back into deficit in 2H20, providing price support which we expect to continue in the coming months. The 12-month Brent crude price forecast is unchanged at $45/bbl but we raised the 3 and 6-month forecasts to $36/bbl (old: $30) and $40/bbl (old: $38) respectively.

Supply side has adjusted fast amid steep production declines in OPEC+ along with non-OPEC countries.

Signs of compliance by OPEC+ with April’s deal to restrict supply are reassuring. OPEC+ agreed in April to cut output by 9.7mb/d. The initial cuts are in place for May and June, with the agreement plotting out 7.8mb/d cuts from July till the end of the year and 5.8mb/d cuts through to April 2022. So far, adherence appears to be strong. Saudi Arabia and Russia have both made the big output cuts they promised.

However, reported disunity among OPEC producers, as they look to extend deeper cuts, could weigh on oil prices. Saudi Arabia is looking to delay a decision to extend the May/June quotas until they can receive sufficient assurances from fellow members – Iraq and Nigeria -- to stop free riding and fully comply on quotas. OPEC+ is set to reschedule its meeting to mid-June to accommodate the finalisation of the May compliance data.

Production cuts outside of OPEC have been swift, albeit painfully and reactively. In the US, the world’s largest oil producer, active oil rigs have plummeted to just 222, the lowest total since 2009. The stronger bounce for WTI compared to Brent, leading to a substantial tightening of the WTI - Brent spread, points to the broader rebalancing of the US oil market. Assuming average prices continue to edge up in 2H20, questions will grow as to whether and how quickly US shut-in production will be turned back on. The rally in WTI prices has already encouraged a number of operators to start bringing shut-in wells back online.

Supply has adjusted much faster than expected, with US shale output in decline

^{Source: Bloomberg, Bank of Singapore}

A gradual recovery is underway in oil demand, occurring in stages with China the furthest ahead, while Europe and the US is a step behind. Easing restrictions in Europe and the US is likely to lead to only a gradual rebound in transportation-driven oil demand. Jet fuel demand remains subdued and any sizeable recovery will depend on international travel restrictions being lifted.

This article was first published by Bank of Singapore on June 5, 2020. The Opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of Bank OCBC NISP Private Banking Tbk. or its affiliates.

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