(Bloomberg Opinion) — As the summer driving season fades in the rearview mirror, oil markets are taking on a distinctly chilly air.
The recovery in demand has officially stalled, just as the OPEC+ countries are starting to taper their record output cuts. With spare capacity rife throughout the supply chain and huge stockpiles of crude and refined products, it may be some while yet before oil prices resume their upward path.
After a strong initial rebound from the depths of the pandemic-induced slump, the comeback in demand slowed dramatically, as I’ve written here and here. This is most obvious in those countries that publish detailed data at high frequency, such as the U.S., the U.K. and some other European nations.
That oil demand in India remains muted is particularly bad news for those wishing oil prices higher. Before Covid-19 struck, it had joined China as one of the major centers of growth in liquid fuel consumption. Sales of transport fuels by the country’s three biggest fuel retailers — Indian Oil Corp., Bharat Petroleum Corp. and Hindustan Petroleum Corp. — were still down year-on-year by more than 20% in July and August.
The one potential bright spot is China, which may yet prove a lifeline for the flagging demand. July’s apparent oil use in the world’s biggest importer was up by a whopping 19.5% year on year, according to Bloomberg calculations on data from the nation’s Customs General Administration. Air travel in the country’s vast domestic market is picking up. Passenger numbers for China’s biggest airlines — Air China Ltd., China Eastern Airlines Corp. and China Southern Airlines Co. — were up by about 25% month on month in July. Travel analytics company ForwardKeys predicts air travel in China will fully recover this month.
But China’s already got plenty of oil on hand. It took advantage of rock-bottom prices in March and April to make purchases, leaving the country’s stockpiles brimming, both on land and in tankers anchored off its coast. The volume in so-called floating storage is coming down, but there are still some 50 million barrels of crude that have been in tankers off China’s Shandong province for more than 15 days, according to London-based consultants Energy Aspects.
Even when demand does begin to pick up again, in China or elsewhere, there may be little immediate impact on crude prices. The devastation wrought by the coronavirus pandemic has left ample spare capacity throughout the oil supply chain.
Take the U.S., for example. Refinery utilization was running at about 81% of operable capacity before Hurricane Laura tore through Louisiana. That compares with about 95% at the same time last year. The difference represents about 2.6 million barrels a day of idle refinery capacity in the U.S. alone. Plants in Europe may be running at even lower levels.
When it comes to getting oil out of the ground, the spare capacity may be even bigger.
While U.S. shale oil production may never recover fully to its pre-virus peak, there is still plenty of room for output to pick up from current depressed levels. In the seven shale basins covered by the Energy Information Administration’s Drilling Productivity Report, there were still more than 7,600 drilled but uncompleted wells at the end of July, a number that has barely changed since February. That may reflect a lack of activity in the shale patch, but the wells provide a buffer from when demand picks up to the point that drilling crews return to the Permian and other shale basins.
But the greatest concentration of spare crude production capacity lies far away in the Persian Gulf and beneath the tundra of northern Russia. The OPEC+ group of 23 countries had reduced their collective production by 9.7 million barrels a day as of May. They’ve since begun easing back on those cuts, raising the combined output target by 2 million barrels a day from the start of August.
Some of that should initially be offset by several countries’ commitments to additional reductions after failing to meet their obligations in full in the early months of the deal. More oil will also be consumed domestically in the Persian Gulf countries to meet soaring summer electricity demand. But neither of those factors will constrain supply for long.
Saudi Arabia’s hard line towards OPEC’s perennial quota cheats succeeded in eliciting promises to make up for earlier shortcomings, but Iraq, the biggest over-producer, is seeking to reduce the severity of its compensatory cuts by extending their duration. And Persian Gulf electricity demand will soon retreat from summer peaks, as temperatures come down, freeing up more of the extra production to be exported.
The chill of approaching autumn may yet make itself felt through oil markets before they rebalance.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Julian Lee is an oil strategist for Bloomberg. Previously he worked as a senior analyst at the Centre for Global Energy Studies.
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