Oil prices

Oil prices have recovered, but downside risks remain

Hans van Cleef - 6 August 2020

Early April 2020, OPEC and its allies announced a production cut agreement of 9.7 million barrels per day (mb/d).

About the author

Mr Hans van Cleef
Hans van Cleef is Senior Energy Economist with ABN AMRO. In this role he covers for the bank the energy market in its broadest sense and gives regular updates (especially oil and gas related, but also wind, solar and the carbon market).
Despite this agreement, oil prices have continued to behave erratically. The effects of the (partial) lockdowns to fight the COVID-19- virus proved to be harsh. Demand has dropped substantially. The estimates range from 20 to 30 mb/d of lower demand in April and early May. The drop in demand has resulted in an oversupply. There are even fears about a possible shortage of storage capacity, especially in the US. As a result of this, Brent oil prices dropped below 20 dollars/barrel, while West Texas Intermediate (WTI) even dropped to minus 40 dollars/barrel.

Oil contracts are traded in contracts for delivery in a specific month. In the case of WTI, if such a contract expires, the owner will receive physical oil. When the contract for delivery in May almost expired, it appeared that there were still some ETFs and hedge funds with WTI contracts in their portfolio. These were difficult to sell due to the shortage of storage capacity.

To avoid physical delivery, at one point these financial institutions even offered money to avoid delivery. This resulted in a negative WTI oil price. When the June-contract expired, there was no problem at all. It seems that hedge funds have learned their lesson. Another reason could be that the recovery in oil demand and the production cuts have started to have an effect and lower the stress regarding a possible lack of storage capacity.

Although we do see some signs of loosening the lockdowns measures, it will take months - if not longer - before the world economy recovers. A recovery in oil demand goes hand in hand with the recovery of the world economy. However, the future scenario has changed. Even if the economy recovers to the pre-COVID-19-levels, oil demand may remain somewhat lower for longer. Working from home could have a more permanent character. Less commuting, more online meetings and more working from home will probably result in more moderate energy use. Companies and public institutions will also have a critical look at the need for business travelling now that online meetings and seminars have proven to be good alternatives.

In the near term, oil prices will continue to remain very volatile. Expectations about oil demand will change continuously, driven by macroeconomic data and how the easing of lockdown measures will proceed. If lockdown measures are eased further, demand for oil will probably grow, and oil prices recover.

Supply and inventories are also closely monitored. The high inventories will cap the upside potential at oil prices. The current (mid-May) recovery of oil prices to above USD 30/bbl is mainly because of hopes for continued recovery and may prove to be too optimistic. Any disappointment or risk-off modes in the financial markets during the coming weeks and months could lead to profit-taking on the newly build long positions and trigger a new downward price correction.

Still, we think that oil prices could recover to USD 40 to 45/bbl at the end of this year. For next year, we expect sideway trading within a USD 40 to 50/bbl trading range.

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