Commodity Analysis

Physical oil rally might be short-lived

Julia Payne/Olga Yagova | Updated on May 10, 2020 Published on May 10, 2020

Output cuts help,but demand recovery still timid

From Kazakhstan to the North Sea and the US, physical crude has jumped in value in recent days, but the rally will likely be tactical and short-lived rather than signalling a proper recovery, according to traders and analysts.

The market, which saw some physical grades selling at prices close to zero just a few weeks ago, is indeed being helped by production cuts by the Organization of the Petroleum Exporting Countries (OPEC) and its allies and in North America.

But as the world starts to ease lockdowns, which have restricted the movement of some 4 billion people to prevent the spread of the coronavirus, oil demand recovery will be slow and timid.

The world first needs to unwind huge stocks of crude and products before refining appetite for crude becomes sustained again.

The physical market is tighter since prompt barrels are stored or floating.

Sellers are in the drivers seat now, said one European trader.

Failing to sell and with a steep contango, trading firms have been scouring the globe to book onshore and floating storage.

A contango market structure means the current value is lower than in later months, which can make it profitable to store oil now to sell at a higher price later.

Even though the market shows signs of recovery, many have hedged their floating storage some six months to a year out and have little incentive to offer their oil now.

Refined products are also being stored at sea, but more is in cheaper onshore tanks.

Further, the structure has not yet flattened out though the front-month contango on futures has narrowed sharply.

Making a profit out of floating crude tankers depends on the tenor of the storage contract, meaning a trader will have hedged for that time period.

The trader will not release the oil until the contract ends, the market is flat or in the reverse structure called backwardation.

Traders at refineries cautioned that the uptick could be short-lived as the higher prices could scare them off. “What we are seeing in terms of refining margins so far in May is worse than in the first two weeks of April, and that’s when crude was cratering,” said Eugene Lindell, senior analyst at JBC Energy.

“There’s simply too much product in storage. A sharp increase in demand for products does not mean the same for crude.

“We’re cautious on this rebound as demand for core products will be up some 7.5 million bpd (barrels per day) in May versus April, while crude demand will rise only up 2 million bpd. Differentials have risen, but from abysmal levels,” Lindell said. Reuters

Published on May 10, 2020

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