The supercharged multi-year oil prices are a reflection of the improved oil demand sentiment, and along with it, the expectation that crude and products inventories will significantly be reduced in the second half of 2021 as a post-pandemic new normal of oil consumption sets in.
Tuesday’s API report of another crude draw in US inventories pushed optimism further in Wednesday morning trading and helped prices rise to new highs above the 70-dollar mark, even WTI.
The clearing out of crude inventories is primarily being driven by the act of driving itself.
In the US, demand for gasoline and diesel is increasing ahead of the summer driving season, which this year is getting an extra boost of momentum as it coincides with the successful vaccination campaign that has allowed the economy to open up and oil demand to tick higher.
In the US, the road traffic index in the first week of June has reached 95% of pre-pandemic levels as drivers hit the pavement. Similar trends are visible in Europe, where the UK, another country with a vaccination rate higher than 50%, has seen road traffic even surpass pre-pandemic levels, now at 101%.
The bullish sentiment likely has some more steam left in it, as the slow supply response will fuel a sustained withdrawal of crude inventories. Our balances indicate an average 900,000 bpd draw over the third quarter.
There are still indications the prices can surge higher. The trading volume of Brent contracts is only at 267,000, still far below the all-time high of 348,000 in late February 2021, when the market was clearly “overbought”.
The relatively low trading volumes of contracts indicate that there is still upward potential for oil prices, and that the $73 per barrel price is not just a frothy tendency.
However, even as some countries open up, others are still seeing prolonged stalls in demand triggers. Japan, which has effectively locked down ahead of the Olympics, has seen road traffic drop to 92% in June compared to 93% in the last week of May.
China saw a drop from about 94% to 92.5% if comparing the first week of June and last week of May. The loss of oil demand in these regions isn’t dramatic, but the lethargic and bumpy recovery could be a harbinger of a slower-than-expected recovery ahead.
The US is a leader in aviation recovery, with flight activity at 68% of pre-pandemic levels, whereas India lags at 36% and Japan at 51% as mobility restrictions still squash the demand to travel by plane.
If oil prices continue their ascent, they will eventually trigger a stronger production response. So far this year, US shale supply has been quite unresponsive to higher oil prices as operators focus on cash flow instead of production volumes.
US oil production likely recovered to 11.2 million bp in March, and we expect a gradual increase in the coming months, mainly driven by the Permian and Eagle Ford basins, with the potential to grow towards 11.6 million bpd by the end of 2021.
However, this will not be enough to balance the entire global market, so other supply responsiveness will be called upon, in particular, from OPEC+.
OPEC+ has increasingly more room to increase production. Our crude-supply demand balances indicate a 2 million bpd deficit in the market for July 2021, but we still expect OPEC+ cutters to produce about 38.8 million bpd in July 2021, still above the 36.2 million bpd target level, but far below levels that would bring the oil price down back closer to $70 per barrel.
