FxWirePro: WTI Bulls On D/S Equation, Refining Margins & Production Reinstating, Trios To Resume Interim Rallies But Unlikely To Reverse Trend

Energy markets have staged a considerable recovery since sinking to a nadir last month. We think the crude oil price has done enough and find the move overextended for three reasons.

First, given the cost of storage and shrinking contango, floating oil storage enough to meet about 7% of the world’s daily demand is about to return inland.

Even with production declining and demand recovering, we still see an additional 90 million barrels of inventory builds between now and September, when we estimate the first monthly deficit will likely emerge.

Second, the combination of rising oil prices and still weak demand looks set to keep refining margins at historic lows over the coming months.

Accordingly, refinery runs across the globe are still a long way off from usual rates, depressing demand for crude.

Third, the economics of restarting production has come into focus.

The return of curtailed production is likely to place near- term pressure on price, ultimately suggesting downside risk for WTI price in June. However, we believe that the progressive return of virus-impacted demand will likely help to continue to provide balance to the US oil market as natural declines take hold of the supply-side. This also assumes that US imports average 2.4 mbd during 2Q’20.

Thus, while our 2Q’20 price forecast will have to be significantly adjusted higher (mostly because of our overestimation in US imports in May), we would assume that our 3Q’20 price forecast of $27/bbl is at risk for a minimal revision higher at the current time. 

The most pressing risk to our current price forecast is the further tightening of the US market in the near term which would further support prices. If this were to be the case, then the US oil market would have to contend with producers beginning to complete wells they deferred as a result of the price swoon observed in March. The assumption at the current time is that the deferral in the completion of wells will last until 4Q’20; however, further near-term price strength could encourage these wells to be completed even sooner as producers bring production shut-ins back on line. While not only adding near-term upside risk to our forecast, we believe this would also provide some downside risk to our 4Q’20 price forecast of $34/bbl, as US oil production would likely realize higher than our current December 2020 exit level of 11.2 mbd. 

Foreseeing the puzzling swings in this energy commodity, the scepticism still persists for the bearish risks. Hence, we recommend long hedges of CME WTI of June tenors, simultaneously, shorts in CME WTI futures of July’20 delivery for the major downtrend. Thereby, one can ensure directional positions amid macroeconomic turmoil as emphasized in our recent posts. Courtesy: JPM