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The oil price rebound may have gone too far, based on just tentative supply and demand improvements

Signs that Americans are driving more as the economy slowly reopens is helping lift oil prices, but a 60% jump in just a week may be too much, too soon.

The pickup in gasoline demand is coinciding with big production cuts, and together that’s a formula for higher oil prices.  U.S. producers are halting drilling projects, and OPEC and its partners began cutting their output last Friday. According to ClipperData, Saudi Arabia’s ship loadings fell to a three-day rolling average this week of six million barrels a day, down sharply from 12 million barrels a day in the prior three-day period.

As more than half the states opened up their economies to some degree, U.S. gasoline demand rose in the past week to 6.7 million barrels a day, from 5.9 million barrels the week earlier, according to government data. That’s still about 3 million barrels a day below normal. According to OPIS, preliminary data from gasoline retailers shows that drivers have increased their purchases of gasoline. They are still buying 37.7% less than normal,  but that’s improved from 50%.

“I think a lot of people are looking at the numbers and saying gasoline demand is looking a little better, not great, but just a little better. Supply has come down and maybe the inventory surplus won’t be as big because OPEC plus is cutting production in May and June,” said Francisco Blanch, head of commodities and derivatives strategy at Bank of America. “The big question is whether the recovery in gasoline demand we’re starting to see is going to continue.”

Citigroup analysts also point to the fact that fuel in storage remains high and even though gasoline supplies shrank by 3.1 million barrels last week, other fuel supplies rose. Distillates, which includes diesel, grew by 9.5 million barrels. Diesel demand is down 20% from a year ago, according to the Energy Information Administration.

“A shift in market sentiment was lifting prices earlier this week, but the physical overhang does not want to go away,” the Citigroup analysts wrote in a note. Crude inventories rose by 4.6 million barrels.

Blanch said if the market comes back too fast and prices rise too quickly, U.S. shale producers could ramp up some production, slowing the draining of surplus crude.   Prices cratered last month, and futures prices fell deeply into negative territory, as traders reacted to growing oil supplies and a shortage of  places to store it.

“I look at where we are today. The reason we are excited is we are past the worst point. If you think about the moment in the crisis where demand was at the lowest point and supplies were at the highest point, we’re past that,” Blanch said. “But we’re not out of the woods.”

Prices are steadier compared to late April, and WTI crude futures for June ended lower Wednesday at $23.99 per barrel, after a volatile session. WTI is up 60% in the past week and was up 22% in the first three days of this week. It was on the move higher again Thursay. Blanch said in the spot market, Bakken crude was back in the $20s after a period in the low single digits and even negative prices.

U.S. drivers play an important role in the world oil market, since they normally consume about 10% of world supplies in their cars each day. With drivers beginning to emerge, a concern among analysts is that there could be a resurgence in virus infections, which could dampen the rebound in activity.

U.S. oil production also matters. The shale industry’s rapid growth in the past decade put the American oil industry on the top of the world, with production surpassing both Saudi Arabia and Russia, now numbers two and three.

The U.S. industry was pumping at record levels even in March, while global demand weakened, but before the virus shutdowns brought it to a halt. Production has fallen to 11.9 million barrels a day, from its high of 13.1 million barrels a day in March.

“”You can feel certainly a change in sentiment,” said Daniel Yergin, vice chairman at IHS Markit. He said the OPEC plus cutbacks and shut-ins of U.S. wells is making a difference. “All of that has changed the equation for thinking about oil prices. What’s happening with the shut-ins, they do become significant numbers and give some relief to the market.”

Yergin said he expects U.S. oil production could be down by 3 million barrels by year end, and analysts say the declines in May could be steep with another million barrels or so coming off line.

Blanch does expect the market to stabilize and even come into balance by Labor Day. He forecasts Brent prices, at just under $30 a barrel Wednesday, will average $25 in the second quarter. He expects that to rise to $33 a barrel in the third quarter and $39 in the fourth quarter. For next year, he expects Brent to average $45 per barrel and WTI to average $42 per barrel.

Shale “producers don’t come back at $15 or $20, but at $30 they’re going to start getting a little looser with their cuts,”  Blanch said. If Brent were to hit $40 or $45, “OPEC might start coming back.”

OPEC and its partners, including Russia, agreed to cut production by 9.7 million barrel a day in a deal that went into effect Friday.

Matt Smith, director of commodities research at ClipperData said Saudi Arabia had been loading more crude at a consistently higher level in April, but this week’s levels are the lowest since March. “Because people are watching these numbers to look for compliance, they’re coming out of the gates in May to signal this oil price war is over, and they’re dialing back,” he said.

The market has also been reacting to signs that offshore tankers are unloading cargoes, said Blanch.

A group of tankers off the California coast have begun unloading cargoes, indicating refineries expect a pickup in demand and will increase production.

Last week, the tankers unloaded 1.3 million barrels a day, the second-highest amount in any week this year,  said Smith. 

“We’ve seen them coming on shore which signals to us these refineries are going to start back up as California opens up,” Smith said. California is scheduled to open some businesses Friday, in a phased reopening.


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