Summary
- Oil prices are experiencing one of the sharpest downturns in history as a lack of storage capacity becomes a key constraint.
- We expect a modest recovery in oil prices if agreed global supply cuts are effective and end-user oil demand starts a recovery, helping work off the oil inventory glut.
- What we are keeping an eye out for: Any additional measures from OPEC+ or the US, speed of economy re-openings and evidence of global oil demand recovering.
What are the reasons and implications of the oil price collapse?
- WTI crude oil prices (measured by the active month contract) plunged into negative territory last week. The root of the problem is likely a lack of storage capacity, exacerbated by technical factors such as lower market liquidity. At the time of writing, the quoted WTI oil price is currently at USD 11.75/bbl while Brent oil is at USD 19.45/bbl
- The move lower in oil prices has also dragged the market’s inflation expectations lower, raising fears the fall in oil prices could exacerbate a ‘deflationary’ shock. However, unprecedented fiscal and monetary easing as well as our expectations of a gradual recovery in oil prices should help mitigate this.
What is your view on oil prices from here?
- We expect WTI crude oil prices to stabilise over the next 3 months as agreed OPEC+ production cuts and the start of a demand recovery alleviate the global supply glut.
- Over the next 6-12 months, our expectations are for a gradual recovery in the WTI oil price to a range around USD 45/bbl.
- Technical watch: There is strong support for WTI crude at the 1986 low of 9.75, which on a weekly basis continues to hold.
What must happen for your view to pan out?
- First, we would need to see a recovery in oil product demand in end-user markets (i.e. motorists, airlines) over the coming weeks as economies gradually re-open. This is likely to be accompanied by a downward adjustment in non-OPEC supply as production falls due to financial and storage constraints.
- Second, oil inventories would need to normalise. Refiners will likely draw down current inventory first before resuming their normal pace of buying.
- The key risks to our view include (i) weak compliance with the OPEC+ output cut agreement and (ii) a slower-than-expected recovery in global oil demand later this year.