The Fuse

Oil Rally Stalls On New Covid Worries. Race to Vaccinate Is Key

by Nick Cunningham | January 22, 2021

The start of 2021 saw crude oil prices shoot up to their highest levels since the beginning of the pandemic. Vaccines began to roll out in earnest, promising a light at the end of the tunnel. OPEC+ is also keeping a lid on supply, stabilizing the market further.

However, a gigantic question mark still looms over the demand picture. While a potentially bright in the second half of the year sits just off into the future, the situation has begun to deteriorate for now. New restrictions in major economies and a worrying spread of a new variant of the coronavirus raises serious concerns about the next few months.

“Balanced” market boosts prices
The delay of OPEC+ production increases and the Saudi cuts of 1 million barrels per day (Mb/d) for a period of months has technically pushed the oil market into a deficit. By mid-January, Brent had jumped to $57 per barrel, a price not seen since the crash last March. “The global vaccine roll-out is putting fundamentals on a stronger trajectory for the year, with both supply and demand shifting back into growth mode following 2020’s unprecedented collapse,” the International Energy Agency wrote in its latest Oil Market Report.

Crude oil inventories in OECD countries declined for four months in a row through November (the latest month for which data is available), and in the U.S., inventories are approaching the top end of the five-year average.

The inventory declines should continue, especially given that global oil production won’t bounce back as fast as demand is expected to. The IEA assumes demand rebounds by 5.5 Mb/d this year, after collapsing by 8.8 Mb/d in 2020. But supply only increases by 1 mb/d in 2021, after falling by 6.6 Mb/d last year. As a result, if global economies begin to rebound, inventories should continue to draw down.

The IEA expects inventories to draw down at a rate of 1.1 mb/d in the first quarter, with “potential for much steeper declines during the second half of the year as demand strengthens.” The Brent futures curve has flipped fully into a state of backwardation – near-term prices are more expensive than longer-dated futures contracts – a reflection of a tight supply-demand picture and declining inventories.

Most importantly, the market – and just about everyone around the world – is eagerly eyeing an end to the pandemic with the rollout of vaccines. On that front, there are tons of reasons to be optimistic, but also reasons for trepidation.

Despite enormous promise with multiple successful vaccines, the pandemic is far from over.

Dark winter
Despite enormous promise with multiple successful vaccines, the pandemic is far from over. In fact, the new variant of the coronavirus that appeared in the UK is thought to be as much as 50 percent more contagious. It is expected to become the most dominant form of the virus in the U.S. in the next few months, and sooner in some European countries.

The world is now in a race to vaccinate ahead of the spread of the new variant. “With a clear risk of new lockdowns ahead due to new coronavirus strains and refinery demand set to ebb off, we see limited upside to crude oil prices over the next four weeks,” Bank of America Merrill Lynch wrote in a note.

In fact, new travel restrictions are already multiplying. “On the demand side, the cocktail is sour, with expanding lockdowns rapidly growing in Asia and Europe. More than 55 percent of Japan’s population is under a state-of-emergency lockdown through 7 February 2021, and China’s Hebei province remains in lockdown,” Rystad Energy’s oil market analysts Louise Dickson said in a January 22 statement. “Most major European cities are living under strict quarantines and curfews, and there are talks of third and fourth iterations of confinements.”

As the near-term outlook has darkened, the IEA cut its demand forecast for the first quarter by 600,000 barrels per day (b/d) compared to a December assessment. The agency also slashed its full-year demand forecast by 0.3 Mb/d.

Moreover, the IEA’s relatively optimistic full-year outlook – that demand increases by 5.5 Mb/d in 2021 – rests on a sudden and large jump in demand in the summer. The agency assumes that demand increases by 3 Mb/d in the third quarter, relative to the second. Obviously, the assumption is that vaccines begin to reach a large portion of major economies and that there is a rapid boost to economic activity. Any delay the vaccine rollout, however, severely undercuts the bullish case for oil. Vaccine supply constraints over the next few weeks, and expectations of the spreading new variant, has already sent a chill through health departments worldwide.

All is not lost. While delays and supply issues have slowed a quick rollout of vaccines around the world, the bottlenecks with the Pfizer vaccine are thought to largely dissipate by around April. Even better, Johnson & Johnson says that its vaccine, pending approval, could be available in the coming weeks, and the company could also add 100 million doses in the second quarter. And that vaccine only requires one shot, instead of two.