Commodities Year Ahead: Oil Likely To End 2020 In Red, Path Up Looks Slippery

From minus $40 per barrel in April to nearly $50 in the positive by December, oil’s 2020 rollercoaster ride was quite unprecedented. The price spout—in true black gold fashion—has enthused oil bulls so much that they’re counting on a further recovery in the new year. But a different reality might await them. 

Oil Weekly Chart

A new variant of the coronavirus has arrived to dampen the ardor in oil, just as the rollout of COVID-19 vaccines from Pfizer (NYSE:PFE) and Moderna (NASDAQ:MRNA) looked promising enough to lift crude consumption toward pre-pandemic levels. 

It isn’t just demand that’s under renewed scrutiny. Production is creeping up as well, despite the best efforts—and promises—of the Organization of the Petroleum Exporting Countries. 

Virus Variant Aside, OPEC Has Libya, Iran Problems

The OPEC cartel seemed in more control of its oil-producing members and allies than previously when they agreed last month to collectively raise just 500,000 barrels per day in output from January, after enforcing cuts of between 8 million and 10 million bpd the past nine months. 

Notwithstanding its discipline on cuts, OPEC gave a free pass to key member Libya to add barrels with little restraint, ostensibly to make up for the civil war that shut its production even before the pandemic. That could be a problem.

Libya’s Sirte Oil and Gas Production and Processing Company has nearly doubled its crude oil production to over 100,000 bpd, compared to the average 55,000-bpd production rate before the blockade. France’s Total (NYSE:TOT), meanwhile, plans to expand its investments in Libya’s oil industry, the NOC said last month, to “the highest levels.” 

Beyond Libya, OPEC has a bigger worry—Iran—which the Saudi-led cartel is trying to pretend isn’t a problem. With Joe Biden’s presidency beginning Jan. 20, the clock will be ticking for his administration to cancel, if not at the least, significantly roll back, sanctions on Tehran imposed by the Trump regime as soon as possible. Biden was, after all, part of the Obama administration that sealed the West’s nuclear deal with Iran in 2015 and he should be eager to revive that pact, which outgoing president, Donald Trump, canceled. 

Iranian President Hassan Rouhani has already said he is eager to bring Iran’s output back to the 2-million bpd level seen in 2018, before the “maximum pain” campaign begun by the Trump administration. Even as Iran tacitly gave its approval three weeks ago for other producers within and outside OPEC to modestly raise their production, it has been working behind the scenes back at home to pump like there’s no tomorrow. 

Iran isn’t OPEC’s only problem. Russia, which has always led the broader oil-producing alliance outside OPEC, said it plans to support a further gradual raise in production at the enlarged OPEC+ meeting in January. 

The reason, given by Russian Deputy Prime Minister Alexander Novak, is that crude prices are within Moscow’s optimal range of $45 to $55 a barrel. Saudi Oil Minister Abdulaziz bin Salman, who has been working to keep any output increases to the bare minimum, hasn’t responded to Novak’s remarks, reported on Sunday. To be sure, it was the Russian’ plans to produce as much as they wanted that triggered the oil output war with the Saudis at the height of the COVID-19 outbreak in March that pushed WTI into negative pricing in April for the first time ever.

If the Russians get their wish for more barrels in January, it might be hard to stop other countries from seeking further hikes later to “cash in” on the current relative highs in pricing—before the market possibly comes under pressure in coming months. If denied, these countries might go ahead and boost output anyway—and “deal” with the OPEC leadership later, says oil economist and geopolitical analyst Osama Rizvi.

In a blog that ran on Seeking Alpha over the weekend, Rizvi adds:

“Another important aspect is the prospect of cheating among OPEC+ members.” 

“With the recent increase of 500,000 bpd, the room for exceeding their quotas has only increased. Last month in November, members of OPEC already pumped 670,000 bpd more as compared to October 2020. Libyan production is expected to reach 1.3 mbpd. Members exempt from production cuts are adding 600,000 bpd to the markets.” 

Shale Could Follow If OPEC Goes Down Path Of More Production

WTI at closer to $50 a barrel is also likely to prod U.S. shale drillers to crank more out of their wells. Since April’s price crash, shale—a one-time formidable foe of OPEC in production before becoming an ally of sorts to the cartel through a deal brokered by Trump—has been quite restrained with output. 

Even so, the U.S. oil rig count—a gauge for determining forthcoming production—has risen 13 weeks out of the last 14, reaching 263 from last week’s count of 258. 

After dropping from all-time highs of just over 13 million bpd in March, U.S. production has steadied at around 11 million bpd, according to weekly data published by the EIA, or Energy Information Administration. With the escalating rig count, production should rise too.

No Evidence Demand Growth Will Be As Strong As Oil Output

The argument, at least for now, is that the demand recovery in oil is tenuous and may just not be able to withstand the production coming on tap.

Earlier this month, OPEC cut its own 2021 oil demand outlook, citing "uncertainty surrounding the impact of COVID-19 and the labor market" on the outlook for transportation fuel in developed economies during the first half of next year. 

The cartel slashed its forecast for world oil-demand growth to 5.9 million barrels a day, down 350,000 barrels a day from its previous projection. In its monthly report, OPEC pegged 2020 oil demand at 89.99 million barrels a day, a decline of 9.77 million barrels a day from 2019 and slightly below its previous estimate. 

The U.S.-based EIA, and the Paris-based IEA, or International Energy Agency, also concur that oil demand will be some 10 million bpd less than projected at the end of last year.

The new COVID-19 variant, which has already prompted some 40 countries to ban travel from Britain, is raising anticipation for another wave of lockdowns and restrictions across Europe. That could severely hit demand for motor and jet fuels, aside from their sheer economic impact. 

Global jet fuel demand, which accounts for almost 10 percent of oil demand, is still down with the Paris-based International Energy Agency declaring a fall in jet fuel consumption contributing to the 80% decline in oil consumption next year.

Global road usage, meanwhile, is 20-25% down, according to the Primary Vision Network, which says that it may worsen to a 30% decline if the U.S. situation got worse.

The game-changer in 2021, compared to 2020, is, of course, the availability of vaccines. As mass inoculations continue across the world, the spread of the virus will, hopefully, be crushed and recovery will sweep in. Yet, it is not known yet how vaccines rolling off assembly lines in coming months will be able to deal with potentially-mutating variants of the virus. 

Also, the damage done to the global economy may be too deep to expect a prompt return to pre-pandemic levels, without gargantuan amounts of government money poured into the affected countries. In the U.S., politics has complicated the passing of only the second coronavirus relief so far, despite incoming president Biden vowing to do more.

Price Recovery Above $50 Will Take Time

Bloomberg oil analyst Julian Lee said while the approval of effective vaccines marked the beginning of a post-pandemic world, “we’d be foolish to think that just because we can see a finish line, it means we’ve actually reached it.” 

He adds:

“There’s still a long way to go and the next few months will be tricky, both for people’s health and wellbeing and for economies around the world and my patch of the woods, the oil sector.”

For now, the oil benchmarks that matter—U.S. West Texas Intermediate and London’s Brent—look set to end 2020 down about 20% each despite the phenomenal rebound of the past ten months. 

Brent is hovering at just above $50 per barrel while WTI is at least a couple of dollars below that. 

Rizvi, the oil economist, notes that the psychological barrier of $50 “is really important.”

He adds: 

“Taking a long position near $50 can be dangerous for investors. A correction is due any time soon - we saw a clear indication when prices slid recently. 

“It can be triggered by any news or development that may cause the sentiments to shift such as an exchange of strong rhetoric between China and (the) U.S. in terms of the ongoing trade war or the possibility of a further increase in OPEC+ production and/or if any member from OPEC starts to cheat. Further complications in the virus may also impact the current sentiment.”