Asia Oil: Market may be starting to price in the prospect of compensation

It was hard to ignore the surge in oil prices during the European session on Friday. 

With supply and demand trends seemingly moving in positive directions, traders boarded the rally bus en masse. Mind you, the speed of movement and the ease with which the market sliced through WTI $40 was a bit of a surprise as that level was thought to be a worrying point around the possible response from US shale to higher prices. And that’s not to mention the fact most traders were watching the rising US Covid-19 case count numbers with a high degree of alarm. 

But as the New York session took over, prices came off due to growing concerns about the second wave of Covid-19 infections. And while the medium to long-term outlook remains positive the near-term risk of further corrections in oil is still high, based on Covid-19 worries alone.

There was an extremely positive move in crude prices Friday. 

The OPEC+ JMMC heard presentations from both Iraq and Kazakhstan on bringing production down and into line with commitments, making up for May’s over-production. The market might be starting to price in the prospect surrounding the principle of compensation as the make-up volumes are not expected and would be a positive surprise. Still, if the process forces compliance, that in of itself would be supportive in the supply data. May conformity was given as 87%; other under-performing countries such as Nigeria and Angola have until June 22 to submit plans of their own.

A media story discussing feedback from two major independent trading houses, Vitol and Trafigura – both of whom see substantial demand recovery as economies emerge out of lockdown, albeit with a note of caution around aviation – likely attracted attention for no other reason that the story likely confirmed the source of the perma bids that had been buying oil around WTI $35-36 for most of June. 

But, importantly, the futures market is supported by robust physical demand and not speculation, which is always a positive sign. As is the substantial drop in US production last week, but that’s perhaps due to the residual effects from tropical storm Cristobal showing up in the data.

More significantly, the oil-directed rig count – an early indicator of future output – also fell by a further ten rigs in the week to June 19 in an industry report issued by Baker Hughes Co. on Friday. Oil production from the US has given up two full years of gains, supporting traders’ modeled hypothesis that the appetite for capital investment in US shale, which had already been tapering off in Q1, could come to a standstill and lead to a more subdued recovery in US shale.