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Oil prices have slipped into the red. We take a look at why.

Oil prices

A mixed outlook picture

It’s the end of the first quarter of 2021 and things are looking strong for oil: prices are up; demand forecasts are high; OPEC & allies are confident they can raise output; vaccine rollout in key crude importers is going well.

Flash forward to the present, and you’ll see a different picture. Uncertainty has crept back into global oil markets. Key benchmarks have fallen away from yearly highs and are trading at levels seen back in April.

At the start of the week, oil was trying to stabilise, but the pandemic may limit that.

Delta-variant COVID-19 cases continue to sprout up at an alarming rate in key crude importers and oil consumers. China and India, for instance, continue to see new spikes totalling tens of thousands of cases every day. They continue to mount in the USA too.

This has caused the reintroduction of restrictions on movement in countries like China. As the oil industry revolves around transport, and eyes on petrol and jet fuel stocks, restricted movement points to lower demand.

China has even closed some of its ports and major oil hubs in response to mounting cases, signposting that lower import volumes are on the horizon.

The spread of the Delta variant has caused some institutions to alter their demand outlooks.

The International Energy Agency said in its latest monthly oil report that demand had slumped by 120,000 bpd in July. It now believes growth would be 500,000 bpd lower in the second half of the year than previous estimates suggested.

“Growth for the second half of 2021 has been downgraded more sharply, as new COVID-19 restrictions imposed in several major oil-consuming countries, particularly in Asia, look set to reduce mobility and oil use,” the IEA said. “We now estimate that demand fell in July as the rapid spread of the COVID-19 Delta variant undermined deliveries in China, Indonesia and other parts of Asia.”

Goldman Sachs’ recalculated oil forecasts predict an increase in oil deficits from 1 million bpd from 2.3 million bpd in the short term, although it does still expect demand to rise alongside vaccination rates worldwide.

OPEC+ has said it feels no need to boost output beyond the already agreed 400,000bpd from August onwards. All of the cartel’s actions since the start of the pandemic have been to blunt COVID’s impact on worldwide markets. There’s still an optimistic tinge to OPEC’s thinking, but we’re by no means out of the woods yet. If anything, it looks like the trees are getting thicker.

The Fed has also signalled it may soon end stimulus in this month’s releasing of July’s meeting minutes. Its $120bn a month bond buying programme has acted as a bit of a cushion for commodities markets. The implication that this could be pulled away soon has also impacted crude oil prices.

Oil markets’ reaction

Key benchmarks have slipped away from their 2021 highs as the demand picture gets muddled.

At the start of July, for example, WTI was pushing above $76. At the time of writing, West Texas Intermediate futures were exchanging hands for around $63.40.

The same can be seen with Brent crude. The UK benchmark was eyeing up breaking the $80 level earlier in July. As of 19th August, Brent had slipped to $66.40.

Hedge funds have been in bearish sell-off mode for the past six or so weeks too.

Reuters reports that hedge funds and other money managers sold the equivalent of 64 million barrels in the six most important petroleum futures and options contracts in the week to August 10th.

Total institutional sales have been roughly 213m barrels, split between 183m sales of crude, and 29m sales of refined oil products.

Are there any reasons to feel good about oil right now?

In a word, yes. There are still lots of positives.

Vaccine rollout worldwide is picking up steam. In the UK, for example, 75% of adults have had their second does, helping drastically slash the number of COVID deaths nationwide. Over half of the US population has been doubled jabbed too. China still has some way to go, but factoring in over a billion people live there, a 24% full vaccination rate is not a bad showing.

1.87bn people, roughly an 8th of the global population, have been fully vaccinated.

Oil rig counts are creeping up too. At its last review, Baker Hughes says nine rigs were added this week. Total US operational oil rigs now stand at 397 – up 172 from this time last year. That said, it will be a strong balancing act to ensure that improved output levels stemming from more rigs does not lead to a price pressure-inducing oil glut.

Crucially, oil stocks are draining. OECD stocks were 131m barrels below the five-year average in June. In the report for the week ending August 13th, the EIA US crude inventories showed a 3.2m barrel drawdown. US stockpiles are now 6% lower than the five-year average too.

It’s very possible that 2022 will likely result in an oil deficit. But for producers like those OPEC states and its allies, this will be a good thing, just on a simple supply and demand basis. What we’re seeing now is possibly just a short term down cycle.

Confidence will return, but it does depend on the Delta variants’ course right now.

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