How the Oil Market Bounced Back From a Year of Crisis
Oil prices have staged a rapid recovery since the biggest crisis to strike the energy industry in decades.
The Organization of the Petroleum Exporting Countries and its allies stepped in last spring to backstop the market by slashing production in the teeth of a collapse in crude prices. This week, the cartel is expected to reach a deal on unwinding some of those cuts.
Here is why U.S. crude prices have roared back above $60 a barrel from a low of minus $37.63 a barrel last April.
Investors Take a Back Seat
Traders and analysts say supply and demand, rather than speculation, have underpinned the rally so far. The ratio of positions held by money managers in WTI futures and options contracts who expect oil prices to rise, versus those who expect them to fall, is below levels seen during the last big run-up in oil prices in 2018. That suggests investors aren’t in the driving seat.
Analysts say that may change if money managers pile into the oil market to bet on the reopening of economic activity.
Oil stockpiles that ballooned at the start of the pandemic have shrunk thanks to output cuts by OPEC, its partners and companies in the U.S. and elsewhere. Concerned that another round of lockdowns would derail efforts to rebalance the market, Saudi Arabia made an additional cut in January.
Analysts say the winter storm in Texas, which briefly knocked out almost half of U.S. crude production, will also help to drain global supplies.
Global demand now exceeds production by 2.8 million barrels a day, according to Morgan Stanley strategist Martijn Rats. The first three months of the year are on course to be the most undersupplied quarter for the oil market since at least 2000, he estimates.
“This market is in a severe deficit right now, which is why the inventories are dropping like a brick,” said Jeffrey Currie, head of commodities research at Goldman Sachs Group. The bank forecasts that Brent crude prices will hit $75 a barrel in the third quarter. They are currently at just under $64 a barrel.
Measuring output and demand in real time is tricky, but the relationship between prices for barrels of oil delivered at different dates suggests buyers are vying for crude. Traders are willing to pay a chunky premium to take hold of crude right away instead of in a year’s time, a far cry from last spring when spot prices fell to a massive discount.
“That’s telling you the market is hungry for oil, that we need oil out of inventories,” said Saad Rahim, chief economist at commodities trader Trafigura Group. “This is not a market that has fully healed, but it is definitely a market that is healing.”
Demand on the Mend
Demand has recovered in China and India and is on the mend in the U.S. and Europe. Americans consumed 18.6 million barrels a day of gasoline and other fuels in January, the Energy Information Administration estimates. That is 26% more than last April, though still down about 7% from January 2020.
Forecasts for further price gains are predicated on the idea that vaccinations and fiscal stimulus will unleash economic activity in the U.S. and Europe. “Beyond Easter is where people will really start to travel and get back on the road,” said Mr. Rahim.
Paola Rodríguez-Masiu, vice president for oil markets at consulting firm Rystad Energy, is more cautious. Based on data such as road and air traffic, she doesn’t expect crude demand to recover to pre-pandemic levels until late 2022.
The Shale Question
Producers are holding back millions of barrels a day of crude, raising a question: Will prices come under pressure if they open the spigots? Analysts expect the OPEC-plus group to boost output gradually through the year, starting with a decision to unwind some of its cuts on March 4.
But traders and analysts say the U.S. won’t churn out 13 million barrels a day, as it did on the eve of the coronavirus crisis, soon. Under pressure from shareholders and creditors to give priority to cash flow, companies haven’t rushed to pump more oil in response to higher prices.
The industry’s newfound discipline has pinned the number of horizontal drilling rigs below levels needed to maintain production at 11 million barrels a day, let alone return output to pre-pandemic levels. That resolve will be tested if prices keep rising, said Ronald Smith, senior oil-and-gas analyst at BCS Global Markets.
Comeback in Energy Stocks
After a brutal 2020 for energy companies, expectations of a return to economic normality have propelled the sector to the top of the S&P 500 leaderboard this year. Yet shares of companies like Exxon Mobil Corp. and Royal Dutch Shell PLC have lagged behind the oil market itself, and stock prices haven’t returned to pre-pandemic levels.
One reason is that investors are mindful that the market’s current strength might not last, analysts say. Another is that money managers expect some oil companies to give priority to reducing their debt loads over shareholder returns. Even before the pandemic, electric vehicles and the proliferation of renewable sources of energy were raising questions about the future of the fossil-fuel industry.
Executives are circumspect. “I feel as good as you can, given some of the uncertainty out there with the residual pandemic effects,” Exxon Chief Executive Darren Woods told analysts in early February.