Balance of probabilities
Oil’s 2020 roller coaster is on a new downward section of track. After respectively falling below $20 a barrel and turning negative in April, Brent and U.S. crude prices recovered to $40 a barrel amid coordinated supply cuts. Fresh falls in recent days make that level look more like a ceiling.
The post-April recovery had some logic. The Organization of the Petroleum Exporting Countries and its allies decided on June 6 to extend their unprecedented 9.7 million barrel daily output reduction into July, changing initial plans to start tapering their cuts. Plenty of countries are coming out of coronavirus-induced lockdowns. In stark contrast to the situation in the second quarter, demand could outweigh supply in the second half of 2020, Morgan Stanley reckons.
A mix of fears about a second virus wave and fallout from the first one has dampened the mood. A larger-than-expected jump in U.S. crude stocks and a warning from the Federal Reserve this week about local Covid-19 spikes in the United States show demand remains shaky. That could undermine rosy forecasts for the rest of the year.
Even if things do improve, there are a number of factors supporting a ceiling around current levels. One is that global oil stocks are way above average. Another is the so-called OPEC+ group’s ability to turn on supply again. Alongside last week’s prolongation of cuts, Saudi Arabia and other leading lights decided to undo an additional 1 million barrels of daily output reductions. That’s just a fraction of the price-crushing spare capacity that Riyadh can turn on if it wants.
Saudi’s propensity to do this will in turn be led by U.S. shale. At $40 a barrel, and in contrast to the last few months, most of the sector is in the money. Daily non-OPEC+ supply that has been shut down due to low prices amounts to 2.5 million barrels, according to Wood Mackenzie. If American producers start pumping away, OPEC+ may want to follow suit to avoid handing them a free lunch.
The surprisingly effective nature of the OPEC+ cut and the enforced shut-ins elsewhere were driven by fear of even lower prices. Attempting to stop producers controlling their greed with oil prices at slightly better levels looks much harder. That suggests scope for further false dawns.