A quick summary of the oil price in 2020
A Saudi-Russian price war; demand and supply shock; negative prices; a 200 per cent rally in the past month – all these events make up a snapshot of the oil market so far in 2020.
Oil prices, for the most part, are driven by supply and demand fundamentals. Entering 2020, global demand for oil was lacklustre. The Organisation of the Petroleum Exporting Countries (OPEC), a group of 14 of the world's major oil-exporting nations, has been working with Russia to cut production since 2016. By March 2020, OPEC and its allies had been reducing output by 2.1 million barrels per day (bpd). Despite weak demand, WTI rallied into the end of 2019 as rising tensions between the US and Iran contributed to the elevated risk premium, pushing the oil price up.
The initial demand shock of 2020 came after the Chinese government imposed a strict lockdown in Wuhan and other cities in the Hubei province. Closure of Wuhan Airport and the declaration of Covid-19 as an international public health emergency had significant adverse effects on the passenger traffic in the region. China is the world's largest importer of crude and its imports have been growing every year since 2003. In 2019, China imported a record 506 million tons of crude oil, an equivalent of 10.1 million bpd, according to Reuters.
In March, as the rate of Covid-19 infections in Europe accelerated, the oil market was rattled by a supply shock. At the March 6 OPEC+ meeting, with WTI prices at $45 per barrel, Saudi Arabia proposed an additional cut of 1.5 million bpd. If approved, this would have brought total cuts to 3.2 million bpd, not including voluntary reductions.
As Russia and Saudi Arabia could not reach an agreement, oil prices plunged to $31 per barrel when the markets opened on March 9. Russia announced that it would increase production instead, forcing Saudi Arabia and the UAE to respond in kind. This price war hit an already oversupplied market, with the International Energy Agency's (IEA) report for March indicating a surplus of 3 million bpd. The acceleration of Covid-19 cases and deaths globally further depressed demand forecasts, driving oil prices to $20 per barrel by early April.
On April 12, the two sides reached a deal to cut production by 9.7 million bpd in May and June, the deepest cut in history. The cut, however, represented only 10 per cent of the global supply – significantly lower than the 29 million bpd collapse in demand.
WTI prices go negative for the first time in history
While the cuts were expected to start from May, April production was the highest in at least 13 months, with Saudi Arabia and the UAE significantly boosting output. As the settlement of the May WTI contract approached, WTI traded into negative territory reaching -$37 per barrel on April 20. The June contract at the time was trading at $21 per barrel. It is important to note that WTI futures are settled physically, by taking delivery of barrels of oil; collapsing demand and limited land storage capacity caused panic, with traders desperately trying to avoid receiving physical barrels of oil.
The latest developments: crude oil price update
In the past four weeks, WTI crude oil price increased from a low of near $10 per barrel to the closing price of $33.25 on May 22. Both the supply side and the demand side of the equation improved markedly.
On the demand side, countries started to ease Covid-19 restrictions and driving trends recovered somewhat. Chinese industrial activity rebounded sharply in April and, as Chinese refineries ramped up operations, the use of crude oil increased.
On the supply side, IHS Markit now expects nearly 17 million bpd to be taken off the market in Q2. In the US, the number of active oil rigs has dropped for 10 consecutive weeks. The rig count is now down to 318 from almost 800 at the beginning of the year.
According to Rystad Energy, the number of fracking operations started in the US is expected to drop to around 300 wells in May, down from 337 in April and 1,238 in February. Data from the Energy Information Administration (EIA) also showed that US production dropped 1.5 million bpd from the all-time high of 13.1 million bpd set in March. Prices also got a boost from the drawdown of the US crude inventories for the past two weeks.
On May 13, the data from the EIA showed the first drawdown in 15 weeks, with stocks falling by 745,000 barrels. The following week, inventories dropped again, by 5 million bpd with the market expecting a build of 1.8 million bpd.
Where to from here: oil price analysis and short-term forecast
Watch David Jones, chief market strategist at Capital.com, go through the oil price chart analysis and explain the technical set up for the WTI trade:
WTI oil price chart analysis suggests that technicals are broadly neutral for the asset. The daily and hourly RSI, a momentum indicator, is signalling overbought conditions, but the break above the daily trend can lead to further price strength. The next resistance level is at $36.60, while on the downside, there is a lot of support around $31.
Trade US Crude Oil Spot CFD
Any oil price forecast invariably depends on global supply and demand dynamics. In the short term, the prices will continue to fluctuate, driven by Covid-19 newsflow on the demand side, and compliance with the production cuts on the supply side.
Global demand has recovered somewhat, from being down almost 30 million bpd in mid-April to about 19 million bpd in mid-May. Several brokers, including Goldman Sachs (GS) and UBS (UBSG), have lifted their oil price forecasts on the back of the positive supply-demand momentum.
However, as prices increase, compliance with the supply cuts becomes more challenging. For the US shale industry, the break-even price is considered to be around $50 per barrel. With oil spot prices at $35 per barrel, producers at the lower end of the cost curve can begin to increase production. It is essential to watch the Baker Hughes rig count numbers and the US inventory levels for any signs of increased production.
With the recovery in oil demand remaining uncertain and geopolitical tensions between the US and China steadily rising, any increase in production will likely put a lid on oil prices. Factset oil analysis puts consensus estimate for WTI prices at $38 per barrel by the end of 2020, indicating limited upside for the rest of the year.