As oil market watchers try to identify outcomes of the coronavirus pandemic, beware of misleading information. While oil demand is inevitably up in the U.S. as state economies reopen, overall it's still depressed. Although OPEC+ made a deal extending the current production quotas last week, this must be viewed as a very short-term success.
On the other hand, doomsayers who predict the end of industries or entire countries because of the recent drop in oil prices should also be considered misguided.
We're still observing how the oil market reacts in the later stages of the pandemic-induced economic collapse, but quick takes are not always correct. Here are the facts:
1. U.S. Oil Demand
Demand for fuel in the United States remains muted, and this will weigh on crude oil prices as refineries continue to pump out more product and add to the stocks of gasoline, diesel and other fuels.
While consumption numbers for gasoline and diesel (distillate) have started to climb week-by-week as states re-open economies, that doesn’t mean the overall outlook is improving. The four-week average for gasoline consumption in the United States fell 22% from this time last year, while consumption of diesel and jet fuel dropped 18% and 64% respectively, according to the EIA.
The decline in diesel fuel consumption should be especially concerning. An indicator of industrial activity, diesel demand has been weak since February 2019. According to the API D-E-I—an indicator of economic activity developed by the American Petroleum Institute—industrial demand for diesel has declined significantly. Although demand for commercial transportation diesel fuel increased during the coronavirus lockdowns, consumption of diesel fuel still experienced its largest monthly decrease on record in April.
In addition to weak demand, an influx of crude oil from Saudi Arabia has helped create the large glut of oil products. Lots of oil from Saudi Arabia was unloaded into U.S. ports in May and the beginning of June. However, Saudi Arabia’s oil exports are falling—by as much as 4 million bpd this month compared to April. A large portion of Saudi crude is dedicated to Asia, so expect Saudi exports to the U.S. to drop very significantly in the coming weeks.
2. OPEC+ Meeting Fallout
Oil markets have not seen many benefits in OPEC’s new month-to-month production setting policies. OPEC+ met on Saturday and decided to extend its current production quotas for an additional month, to the end of July. The agreement was not surprising to markets as both Saudi Arabia and Russia telegraphed their intentions early last week.
After the press conference held by Saudi energy minister Abdulaziz bin Salman and Russian energy minister Alexander Novak on Monday morning, oil prices fell by several dollars. Saudi Arabia got what it wanted out of the OPEC+ decision—a reason to increase the price of the crude oil it was selling to Asia in July by $6.00 per barrel.
Why did oil prices slip by as much as 3% after the press conference? Saudi Arabia stated it would not extend its extra, voluntary 1 million bpd production cut after June and the OPEC+ group planned to meet again in July to reassess the market in any case. At that time it could decide to increase production. This signaled to the market that OPEC+ isn’t invested in long-term market management but rather is making reactionary decisions based on the short-term. As a result, this month’s volatility is likely to repeat next month.
3. Distress Is Not Disaster
A new report from the Institute for Economics & Peace made headlines this week when it declared that the economic effects of the coronavirus might “result in the collapse of the shale oil industry in the U.S. unless oil prices return to their prior levels.”
Those following U.S. oil production carefully understand that this statement is a worthless risk assessment delivered by analysts who do not understand the oil industry in the United States. It's true that there are many oil companies in the shale region that are performing poorly and may collapse. However, the industry is comprised of a diverse group of companies, each of which is fighting to survive in the current low-price period.
Some companies are going bankrupt, but others are even considering bringing shut-in wells back online. The industry is redefining itself during this period of economic distress, but it is not collapsing.
Low oil prices do cause economic tension that can lead to political tensions. The report mentions Iraq, Saudi Arabia and Iran as countries in the Middle East susceptible to political instability as a result of low oil prices. However, low oil prices themselves do not cause political instability—how the government responds to this challenge potentially could.