Crude oil is well and truly on recovery path

G. CHANDRASHEKHAR | Updated on April 05, 2020

Is the oil tide turning? Political developments of the last couple of days suggest crude oil market may have already bottomed out and is well on its way out of the doldrums. To be sure, after languishing at multi-year low of $25 a barrel on March 27, Brent crude moved up to $35 a barrel last Friday, a gain of 40 per cent in a week.

The sentiment appears to be changing from one of despair to hope. While it is nobody’s case that crude oil will regain all the enormous loss Covid-19 inflicted and go back to its pre-crisis levels (above $60 a barrel), there is strong indication that prices are slowly but inexorably on the recovery path.

Double whammy

Without doubt, the global oil market is facing a double whammy. It is in a state of large surplus on the supply side while the demand side is decidedly weak with economic and travel activities around the world grinding to a near-halt. To arrest declining growth, all major economies have significantly lowered interest rates and enhanced liquidity considerably.

In a turn of events that was waiting to happen, the US President has prevailed upon both Saudi Arabia and Russia to bury the hatchet and agree to cut oil output further. In a self-defeating move, the two countries have been pumping out record quantities of oil in recent weeks to retain market share. The OPEC+ has scheduled an emergency meeting on Monday to explore the option of output cut. The US is likely to join the fray and agree to cut its shale oil output.

Output cut vital

If no agreement is reached, crude oil market will reverse all the gains and go into a free fall. To arrest any reversal and keep the sentiment buoyant, a very substantial output cut will have to be agreed to. Some observers are speculating that nothing less than 10 million barrels a day output cut would help support prices while others are talking about an ambitious 15 mbpd.

This is because the market is deeply concerned about the spread of the virus and the number of people affected. Lockdowns, forced inactivity in the manufacturing and services sectors and huge loss of productive mandays combine to exert a strong negative effect. So, not only the quantum of production cut but also the progress of the pandemic, including any sign of success in its containment, will be the key driver.

Positive signs from China

China’s gradual return to economic activities (as evidenced by latest PMI) is seen positive for the energy market. Also, ultra-loose monetary policy and unleashing of humungous liquidity will, at some stage, encourage liquidity driven commodity boom as was witnessed during the post-2008 crisis. Speculative capital is waiting to seize the opportunity.

So, to expect that the crude oil market will continue to remain in the doldrums (less than $30 a barrel) would be wishful thinking, unless a supervening event such as a catastrophic spread of Covid-19 were to materialize.

(The writer is a policy commentator and commodities market specialist. Views are personal)

Published on April 05, 2020

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