Oil hopes for the best, but prepares for the worst

By | May 12, 2020
Oil hopes for the best, but prepares for the worst

While investors are weighing what is behind the unexpected decision by Saudi Arabia and its allies to cut oil production beyond the OPEC+ set volume, Brent and WTI are frozen in consolidation. At first glance, Riyadh’s decline in production from 8.5 million b/d in May to 7.5 million b/d in June, which was supported by the UAE and Kuwait (-180 thousand b/d), is a “bullish” factor for black gold. On the other hand, if someone wanted oil from the Middle East, they would buy it. Perhaps no one needs it, and Saudi Arabia is trying to put a good face on a bad game with its statement. If so, the “bullish” trump card can actually be regarded as “bearish”.

It is obvious that the main driver of the collapse of Brent and WTI in 2020 was the pandemic and the associated lockdown and reduction in global demand for black gold. It would be logical to assume that the improvement of the epidemiological situation and the opening of the world’s leading economies should lead to an increase in futures prices. Indeed, the increase in air traffic and the first increase in April car sales in China in two years (+4.4% y/y), as well as the growth of fuel sales by retailers in the US by 7% in the week to May 8, are the first swallows of a change in the situation for the better. However, the second wave of the pandemic and the resumption of a trade war between Washington and Beijing may seriously reshape the picture.

A drop in global demand of almost a third due to coronavirus has led to the growth of commercial stocks in the US at the fastest pace since records began in 1982. The indicator reached 532.2 million barrels and only a few doubt that in the near future, it will surpass the record set in March 2017 of 535.5 million barrels.

Dynamics of commercial oil reserves in the United States


Reduced demand and lack of storage facilities are forcing American oil producers to reduce production. This fact, paired with the gradual opening of the world’s leading economies and an increase in interest in black gold, also encouraged the “bulls. Unfortunately, if the US-China trade conflict escalates and the second wave of the epidemic hits, their hopes will turn into lost illusions.

The situation may be modeled on the great depression of the 1930s, which is often compared to the current recession because of its depth. Then industrial production first fell by more than half, then for almost four years the indicator slowly grew, but in 1937-1938 again sharply collapsed. It was about a W-shaped recovery. If history repeats, the oil market will remain depressed for a long time. However, in my opinion, Beijing and Washington will find a common language in the run-up to the US presidential elections, and the second wave of COVID-19, if it happens, will be less painful than the first. These assumptions allow me to recommend holding long positions on Brent formed on breakouts of $25.75 and $28 per barrel, and increasing them on declines.

Technically, after leaving the descending trading channel, the North sea variety entered the ascending one and continues to count on the implementation of the target by 88.6% using the “Shark” pattern.

Brent, the daily chart


*The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.