The Risk of Over-Correcting a Low Crude Oil Price Environment

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It is no secret the COVID-19 pandemic transformed the global energy market in 2020. The virus’s extraordinary hit on crude oil and transportation fuel consumption—and the ensuing price crash—leaves the market wondering if, and when, a full price recovery would occur.

The current market sits in a state of significant oversupply and historically low demand – resulting in a dramatically flooded crude oil market. To correct the low-price environment, supply and demand will need to be rebalanced—a simple economics problem, complicated by nearly 30 percent of built-up crude oil inventories.

Read more about 2020’s historic energy market trends and records, here

For oil companies and some economies that are dependent on healthy crude oil prices for their financial success, taking steps to rebalance the market will be imperative. Because of the magnitude of the downturn experienced thus far in 2020, the urgency these players will feel to achieve recovery raises the possibility of a market that overcorrects itself.

If too many factors swing too quickly, the scales will tip and send prices in the opposite direction. This becomes possible if transport fuel demand makes a resurgence and supply continues to come off the market at its current pace. After all, high prices cure high prices, and low prices cure low prices.

2020 Crude Oil and Transport Fuel Price Behavior

The crude oil and wholesale diesel price freefall that consumed most of the first and second quarters of 2020 has now begun its slow but steady recovery. Economies in the U.S. and abroad are taking steps to return to a revamped state of “normal.” For crude oil suppliers, that will require a motivated effort to lower production, deplete inventories, and boost prices.

Collectively, this has offered cautious optimism that the global supply-demand gap will tighten, and diesel prices will gradually rise. National wholesale diesel prices have regained over 35 percent of their value since dropping to the lowest level in the 16-year history of Breakthrough at the end of April.

Recent momentum suggests prices likely will not fall lower than what was seen earlier in Q2. These market developments may contribute to long-term diesel price increases.

Crude Oil Supply Comes Offline

The Organization of Petroleum Exporting Countries and its allies (OPEC+) agreed on record-high production cuts earlier this year that began to chip away at the world’s drastic oil supply glut in May. The alliance’s oil-dependent economies are now contributing to a cut quota of 9.6 million barrels per day through July, before the quota incrementally decreases, assuming prices respond accordingly.

Meanwhile, other major oil producers—like the United States—have also scaled down operations in an attempt to lift prices to more economically viable levels. U.S. crude oil production has already decreased by over 15 percent since reaching record highs in February. The International Energy Agency estimates over 12 million barrels of crude oil were removed from the market per day in May as voluntary and involuntary production changes came to fruition.

 

U.S. Energy Information Administration

The U.S. can be thought of as a microcosm for similar strategies being executed internationally. Many nations cannot break even or balance their budgets when oil prices are at or below current levels. This has resulted in more aggressive production restraints that mitigate some financial headwinds and will progressively restore market balance.

The energy landscape is currently experiencing a game of “survival of the fittest.” Many oil-rich regions have also been forced to shut in production wells or even close down entirely. In the U.S., for example, refiners were recently operating at their lowest rates since the Great Recession. This puts the longer-term supply picture in question as some key players will be unable to simply flip a switch when called upon to push product to market.

Demand for Transport Fuels and Other Crude Oil Refined Products Returns

COVID-19 remains the biggest wild card for the international energy market’s demand picture moving forward. As it currently stands, many major economies are proceeding with the removal of virus lockdown measures and are restarting their economic engines to some extent. The relaxation of virus containment efforts and stay-at-home orders means consumers are returning to the roads and the need for many transportation fuels—like gasoline and diesel—suddenly re-emerges.

U.S. Energy Information Administration

The virus will continue to act as a demand shock through the summer, with uncertainty about COVID-19’s lifespan and measures taken to fully contain it still lingers. Fears of a second wave of COVID-19 cases and lockdown requirements could materialize, but demand will eventually return to a more normal state. Timing, however, is difficult to gauge.

This will undoubtedly test the global supply-demand picture and put world supply under a microscope as the risk of a market in shortage could intensify. The International Energy Agency recently reported fuel demand in 2021 will bounce back, but finish 2.5 percent below pre-virus levels, reinforcing the magnitude of COVID-19’s demand destruction.

What’s Next for Crude Oil and Diesel Prices?

At present, it appears crude oil and wholesale diesel prices will trend upward through the second half of 2020 and into 2021. This is primarily due to supply and demand-side actions already taking shape. A full-blown demand return, paired with lasting measures to curtail supply and lift prices, could evolve into a scenario in which an over-supplied market flips entirely.

Much of this speculation hinges on COVID-19’s longevity and how prices respond to current market developments, but it is a possibility. Should this transpire, energy price increases that we have seen thus far would continue to rise and could, eventually, get to a price point at or above those seen before the pandemic struck. Current energy market fundamentals and the virus remain extremely fluid, making it difficult to pinpoint whether overcorrection is imminent. If supply and demand continue to converge because of current circumstances dragging on, however, the fuel market will again take on a new identity.

For more information about how the novel strain of coronavirus (COVID-19) has influenced the fuel and freight markets for shippers, visit our resources page.

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