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While anxiety about outright demand declines is legitimate (though we believe policy-makers will act to prevent an economic collapse), fears of surging shale production should ease given that Q2 19 earnings season thus far has seen shale producers guiding towards lower H2 19 output and a lower percentage of oil production. The latest data show May output fell m/m while January–April production was revised lower; US production is unlikely to surge.
Yet flat price has failed to catch a bid even as the physical market has tightened quickly amid a rapid recovery in margins. The overhang of July/August cargoes has largely cleared, with several medium and heavy diffs trading at record highs, and September crude programmes clearing fast.
Even visible stocks are falling fast. Over the last seven weeks, US crude stocks have fallen by 49 mb versus the five-year average draw of 21 mb and, with the exception of Japan and India, stocks are drawing rapidly worldwide. Crude stocks that had built up over April and May have been completely run down, but stocks aren’t low enough for the market to realise things are too tight.
Only once stocks are critically low will flat price rise. For now, timespreads will continue to outperform flat price, possibly through H2 19, especially as producers continue to aggressively sell the back of the curve and hedge production. Indeed, while the market would have sold off due to Trump’s additional tariff announcement on China, the move was exaggerated by Occidental Petroleum’s massive 2021 hedging, as those who had bought those hedges were forced to liquidate their positions. With Pemex still to put through their hedges at a time when liquidity is low due to northern hemisphere summer holidays, headwinds to flat price abound.
|Fig 1: Oil cut of US production, % boe||Fig 2: Brent price vs front-month spread, $/bbl|
|Source: Company reports, Energy Aspects||Source: Datastream, Energy Aspects|