It may seem remote right now, but despite the recent unparalleled loss of global oil demand, economic forces will sooner or later conspire to rebalance the market as demand recovery takes hold and crude production in high-cost regions falls.
Price recovery is on the horizon and it seems likely that Atlantic basin benchmark North Sea Dated will steadily strengthen over the course of 2020 and into next year.
The recent Opec+ agreement to restrain oil production is impressive. It is the largest, most comprehensive oil market management agreement ever achieved. And it needed to be, given the loss of so much oil demand in such a short space of time. The Opec+ alliance agreed to cut production by 9.7mn b/d in May and June, by 7.8mn b/d in the second half of 2020, and by 5.9mn b/d for 2021 and the first quarter of 2022. We would make three observations — the May-June cut helps, but it is not enough; the reduction between July and December looks broadly in line with what is needed; and the extension of such deep cuts into 2021 will probably not be necessary.
In the near term, producers are fighting a lost cause and there is little chance that crude prices will strengthen. The sheer scale of the fall in global demand means that despite cuts by Opec+ and the loss of production in higher-cost non Opec countries, there will still be a large build in global stocks in the second quarter. It is hard to see the current recovery in crude prices continuing in this environment.
The second quarter will not be pleasant for crude producers, but the market is likely to be at the bottom. Opec+ cuts, economically enforced reductions in other non-Opec supply, and demand recovery will help tighten the market. Assuming high Opec+ compliance with agreed cuts, the market may have effectively rebalanced by the start of 2021.
For refiners struggling with weak demand for transport fuels, miserable product crack spreads and low refinery utilisation, a recovery in crude prices will only make matters worse. Jet fuel crack spreads have recovered slightly in the US but remain deep in negative territory elsewhere. Prices will rise in the second half of this year as crude strengthens and as low refinery utilisation and refiners’ efforts to push surplus jet fuel into the diesel and gasoline pools reduce supply. This may improve the situation for refiners slightly, but it will represent an unwelcome higher expense for struggling airlines — although higher fuel costs may be irrelevant if there are no flights in the first place.