While OPEC has helped global oil markets recover from the coronavirus crisis, the cartel will soon face a new challenge: the mountain of unwanted crude that piled up during the pandemic.
When the Organization of Petroleum Exporting Countries and its partners meet in just over a week, the unprecedented accumulation of oil inventories should have finished. Vast production cuts by the cartel, along with a recovery in demand, will have brought the market back into balance.
Yet by that time more than a billion barrels of crude will have poured into the world’s storage tanks, according to a range of analysts and consultants. Burning through the remaining surplus -- a key driver for the next move in crude prices -- will be OPEC’s next big obstacle.
“Even with a conservative view -- assuming a recovery in demand and OPEC sticking to the deeper cuts -- it will take until the middle of next year to reverse the inventory build,” said Harry Tchilinguirian, head of commodity markets strategy at BNP Paribas SA.
Estimates of the size of glut vary, due to uncertainty over just how badly fuel consumption was hit this quarter, when lockdowns aimed at containing the coronavirus drastically reduced travel by air and road, and paralyzed economic activity around the world.
Though fears that the excess would overwhelm available storage capacity -- aired by traders like Gunvor Group Ltd. and institutions such as the International Energy Agency -- weren’t realized, the amount of oil amassed is nonetheless substantial.
World supply probably exceeded demand in the first half of 2020 at an average rate of about 5.5 million barrels a day, causing inventories to balloon by just under 1 billion barrels, according to consultants Rystad Energy A/S in Oslo. Citigroup Inc.’s estimate is a fraction higher.
If half of the billion-barrel surge landed in the tanks of industrialized nations, which account for roughly 50% of world oil consumption, stockpiles there would easily surpass the record of 3.13 billion barrels reached in 2016, according to Bloomberg calculations using IEA data.
The most important factor behind a recovery in oil markets however isn’t the overall inventory level, but how quickly it changes, said Ed Morse, head of commodities research at Citigroup in New York. During a previous slump in 1998-1999, the price recovery took hold once the increase in stockpiles began to slow.
“The rate at which inventories are building or drawing is far more significant than the level of inventories,” said Morse.
That pace will depend on the strength of recovery in demand, whether OPEC and its partners stay the course on production curbs, and how fast supplies outside the group such as U.S. output can recover.
The 23-nation OPEC+ coalition, led by Saudi Arabia and Russia, will decide on June 9 and 10 whether to continue with its current cutbacks --which now amount to about 11 million barrels of daily output, or roughly 11% of world supply -- or ease them in July as originally envisioned.
Moscow wants to relax the curbs as scheduled. Yet as OPEC+ has often made stabilizing inventories at average levels its objective, it could keep supplies tight.
If the cartel remains disciplined and fuel use accelerates, then the record inventory surge seen in the first half of 2020 will be largely erased by a similar depletion in the second, Morse predicts.
That will bring the most important inventory metric, the number of days of anticipated consumption it can meet, known as forward cover, back to pre-crisis levels in late autumn. Forward cover stands at 51.8 days this month, and should subside to 36.3 days in November, roughly in line with January levels, according to Citigroup.
The re-balancing could be even quicker if the glut isn’t as big as widely perceived.
Kayrros SAS, a consultant that uses satellite imagery to measure oil flows, estimates that stockpiles increased by about 500 million barrels through to late May, far less than the banks project. Oil demand in China probably didn’t collapse as much as believed during the height of the outbreak, as refiners outside of its epicenter took advantage of cheap crude prices to crank out more products.
Furthermore, “some of that oil was put into strategic storage and will remain off the market for a long time,” Tchilinguirian said. The U.S., China and India have topped up emergency reserves.
Yet there is also a number of risks that could impede the process. A second wave of coronavirus infections could derail the nascent recovery in oil demand, U.S. shale output could bounce back, or higher prices may tempt OPEC+ nations into ramping up sales again.
“A word of caution is warranted,” said Bjornar Tonhaugen, Rystad’s head of oil markets. “The recovery in oil prices back to ‘normal’ levels of $50-60 will take time and only possible through a simultaneous recovery in demand, and production management.”