After collapsing to nearly $13/bbl, the June WTI contract is slowly making its way back to the $25.5/bbl, nearly doubled in value after all the index and U.S. Oil Fund (USO) ETF rebalancing games. One can argue that the low was artificial in the first place and only a result of a physical market glitch. This was compounded by indices exiting from the June contract in a very short space of time. However, the 7%-8% daily price moves, up and down, are limited to only the front end of the oil curve given the extreme selling going into the May contract expiry and the physical market glut.
As is typical of most experts, after WTI prices went negative in April, there were calls for -$200/ bbl even possible as they preached that global storage tanks would run out of space. Such is the beauty of commodities that inventory balances can distort the market in either direction, but the market does find a way to reach an equilibrium, either by demand destruction or supply cutbacks. In this case, the latter is the reason why the market is slowly catching up post extreme lows.
The entire world was in lockdown mode in March and April, where we saw demand loss of about 30 mbpd. This came at a time when supply was also maxed out as Saudis and the Russians were pumping at will causing a big storage problem in a short period of time. In May, economies are slowly returning from their post lockdown phase, and cars are slowly back on the road and businesses restarting. Demand is still quite low, nowhere close to the "normal" trend levels of January, but it is recovering from dire straits. In May, we now have the full OPEC+ production output cut of 9.7 mbpd taking effect. But something else is helping too.
As WTI prices are below $30-35/bbl, U.S. shale is closing off wells at an incredible pace as the production is no longer feasible, let alone economic. According to the U.S. Energy data, about 1.1 mbpd of U.S. oil output has been shut in. This past week showed U.S. domestic oil production at 11.9 mbpd, down from 13 mbpd earlier this year. Judging by the company announcements, May is expected to see even more closures. As far is the oil market is concerned, these are steps in the right direction - lower supply and higher demand.
Global storage demands are easing a bit as seen by the floating storage. Producers are shutting down their oil production, so storage tanks will not be maxed out. If you assumed the same rate of oil supply as in March, it could have reached the tipping point, but prices had to drop lower and force them to close production to avoid that problem. The last few weeks of oil inventory data have showed crude builds, but lower than the weeks prior. There is still an excess of inventory but the rate of change is lower. The market is cheering this. Given the extreme volatile moves up and down, the market is slowly trying to normalize and find some sense of balance.
As we enter the summer driving season, gasoline demand is going to be very important. Over the last two weeks, we are starting to see inventories draw down, a healthy development. But there is still a lot of inventory to get through before we can call the market "tight". It is still some way above the five-year average. This is going to be key going forward as the U.S. comes back from its lockdown. If Americans start to drive more and gasoline demand picks up, it will support crude demand.
For now, recovering from oversold levels makes sense. But is this the start of a full-blown price recovery? It remains to be seen.
