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View: Demand growth, moderate supply increases by OPEC+ to support oil in short term

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Fuel demand climbed has risen to its highest since April as pandemic-related restrictions and lockdowns were lifted in most states, writes Navneet Damani of Motilal Oswal Financial Services.

View: Demand growth, moderate supply increases by OPEC+ to support oil in short term
Oil prices faltered last month as a resurgence in Covid infections threatened demand in China and the US. China was the epicenter for a huge selloff in the markets, which seemed to have subsided as authorities appeared to have contained the spread of infections successfully in certain Chinese cities.
The main reason behind the falling crude oil prices is the slower-than-expected growth in China, which, in turn, affects the use of crude oil in the country. China is the world’s top importer of crude oil. It is second only to the US as a consumer.
The Delta variant of Covid-19 remains a major concern for oil prices. In Australia, Sydney’s two-month long lockdown will be extended till at least the end of September. In the US, more companies have announced plans to keep workers at home as the virus spreads.
Currently, aviation remains the weakest component of the global demand equation at the moment with the risk of further restrictions on domestic and international travel to increase on account of the Delta variant. That will be a key concern for oil over the remainder of the second half of 2021, particularly as the US driving season ends.
For shale players, the industry is facing the biggest test yet of its newfound resolve to act with discipline and focus on investor returns as opposed to obsessing over growth. The supply response is muted in 2021 as operators are remaining committed to capital discipline and on returning dividends to shareholders after the tough previous year.
Estimates suggest that US supply will only marginally increase this summer, nowhere close to filling the gap that potential OPEC+ inaction would create. Should US shale operators follow the price signal and decide to increase production, it would take at least nine months to see a meaningful supply. Therefore, boosting the output carries a considerable risk due to the volatility that surrounds oil demand and price trajectories.
Where China goes, investors follow!
China has imposed new restrictions with its 'zero tolerance' Covid policy, which is affecting shipping and global supply chains. In July, China imported 41.24 million tonnes of crude oil, a decrease of 19 on a year-on-year basis; from January to July, it imported 301.83 million tonnes of crude oil, a drop of 6 percent on year.
Chinese state-aligned media has identified the following key reasons for the decline in growth:
  • Falling retail sales
  • Falling industrial output
  • Flattening overseas demand
  • Rising crude oil prices
  • Devastating floods in some regions
  • Now, the traffic in China’s typically busy city streets appears to be recovering as the key crude-importing nation quashes the resurgence in Covid cases. This will be supportive for crude oil prices as a slow demand recovery in China is an important support for the prices.
    For India, oil refiners' crude throughput in July bounced to its highest in three months, as the easing of Covid-related restrictions boosted economic activity and fed the demand for fuel. According to provisional government data, refiners processed 4.58 Mbpd of crude oil last month, about 1.9 percent higher than 4.50 Mbpd in June. On a year-on-year basis, refiners' crude oil throughput in July jumped about 9.6 percent while crude oil production declined about three per cent to 6,02,000 bpd.
    Fuel demand also climbed last month to its highest since April as pandemic-related restrictions and lockdowns were lifted in most states.
    The OPEC+ group is scheduled to meet on September 1, and market-watchers expect it to press on with a planned revival of oil production when it meets again next week, as prices bounce back from their August stumble.
    The outlook for oil demand is slowly improving and there’s an inflation pulse rippling through the commodity sector, which supports crude oil.
    West Texas Intermediate (WTI) futures are expected to remain at $70 per barrel in the coming months as the output increments are largely in line with investors' expectations. Healthy demand growth combined with moderate supply increases from OPEC+ will likely remain supportive for the oil market in the short term at least. However, the Delta strain can shake up this bullish forecast and push the price below $63.
    -- Navneet Damani is VP- Commodities Research at Motilal Oswal Financial Services. The views are his own.