Irrational Exuberance Hits the Oil Market
There are many reasons to stay cautious about a recovery in oil demand, and Covid-19 is only one of them.
Covid-19 vaccines are raising hopes of a swift recovery in oil demand next year, but markets seem to have thrown caution to the wind.
Brent crude hit $50 a barrel last week, its highest level since March, before the Covid-19 pandemic really began to tear a hole through people’s lives and economic lockdowns hammered oil consumption. This looks like irrational exuberance given there’s such a long way to go before crude oil markets get back to normal.
Brent Bounce
Brent crude is the highest since March, before the pandemic slashed demand
Source: ICE Futures Europe Commodities
Vaccines are undoubtedly good news, but there are buts....
It’ll take months for a significant proportion of people to get inoculated. Even with a mass vaccination program underway in the U.K., the country’s health secretary, Matt Hancock, warned on Thursday that “for the next few months we will not have sufficient protection” to ease restrictions. We don’t even know yet if people who have been inoculated can still spread the disease.
It’s more likely that many countries will see more lockdown measures first. We still have to get through winter in the Northern Hemisphere, a period when the virus is expected to flourish. Large family and social gatherings during the holidays will fan contagion. And surges in cases will inevitably be followed by further restrictions on travel and further blows to economic recovery.
Recovery from the virus’s huge impact on economic activity won’t happen overnight. Take for example commercial flights, which are stuck at about 60% of last year’s levels after a rebound stalled in August. Hardest hit has been international travel, which accounts for almost all of the long-haul air traffic that’s the biggest consumer of fuel. How quickly those flights come back will depend on governments trusting each other’s vaccination regimes. If rollout is slow, or take-up is poor, vital air corridors may remain closed.
Stalled
Commercial flights are stuck at around 60% of last year's level
Source: Flightradar24
Note: Includes commercial passenger flights, cargo flights, charter flights and some business jet flights
Covid isn’t the only thing to watch. Rising tariffs on trade, a potentially chaotic end to the U.K.'s membership of the European Union and the possibility a new U.S. president will be hobbled by a hostile Senate may all slow the pace of economic recovery.
Even when consumption of transport and industrial fuels starts to pick up, which it’s expected to do next year, there’s a long way to go before that translates into a similar increase in crude oil demand. Huge surplus stockpiles of refined products need to be drawn down first. At the end of September, they were up 9% year-on-year in the developed countries of the OECD, according to the International Energy Agency.
Dissenters will argue, rightly, that China’s crude oil imports are on track to rise by 10% this year. But that’s mostly due to big purchases made when crude prices collapsed, with a lot of the extra supply going into storage tanks. The country’s exports of refined products in October exceeded last year’s level, as processing runs ahead of domestic demand.
Surge Over
This year's growth in China's crude imports was driven by a surge that's now ended
Source: Tanker tracking data monitored by Bloomberg
Even when demand from refineries does begin to rise, there are excess stockpiles of crude that also need to be drawn down. OECD crude stockpiles were up by 11% at the end of September, compared with a year earlier, and by 14% compared with 2018. In the U.S. inventories of crude and gasoline are both at their highest in at least a decade for the time of year.
On the supply side, the OPEC+ group of oil producers will add 500,000 barrels a day to oil supply next month. That’s less than initially planned, but could still be enough to tip an expected worldwide draw in oil inventories in the first half of 2021 into another build.
The rise in crude prices that we've seen in recent weeks is already squeezing refining margins, making it less attractive for plants to pull crude out of tanks and process it into refined products. The only ways for margins to improve are for refined product prices to rise — another headwind for demand growth — or for crude prices to fall.
While the new vaccines are a light at the end of the tunnel, there's still a long way to go before we emerge from the darkness. Oil markets are getting ahead of themselves.
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