Oil rally extends for a third week

Time spreads improve along with spot prices.

By Edward Bell

Oil prices extended their recovery for a third week running as sentiment toward demand improves as more countries ease their lockdown conditions and allow for economic life to return to something approximating pre-coronavirus conditions. Brent futures gained nearly 5% over the course of the week to settle at USD 32.50/b while WTI closed the five days at USD 29.43/b, up nearly 19%. For the month of May alone the improvement in oil futures has been dramatic: Brent has gained nearly 30% while WTI is up by around 56%. June WTI futures expire this week but the relative improvement in sentiment toward crude and easing concerns over whether storage was reaching tank tops should prevent a repeat of last month’s hysteria when expiring futures moved into negative prices for the first time ever.

The IEA gave something of an endorsement to the narrative that oil market are rebalancing in its latest Oil Market Report. The agency still expects to see annual demand this year decline by 8.6m b/d, a slight improvement on its previous forecast, but noted that supply is adjusting quickly to the lower demand environment, thanks both to the OPEC+ production cuts as well as a decline in activity in higher cost producers like US shale. The IEA did warn that “huge uncertainties” over the outlook remain in place but that at least in the near term, the worst of the decline in oil markets may be behind us.

Futures curves reflected the improving sentiment around oil as well with front month spreads in WTI ending the week almost flat and actually did pop into backwardation albeit very briefly—and very tentatively—on Friday. Brent spreads in 1-2month ended the week in a contango of just USD 0.3/b compared with more than USD 1/b a week earlier. Time spreads in the Dubai swaps market also narrowed substantially, ending the week in a contango of just USD 0.32/b. The erosion of time spreads may seem some storage trade unwound, particularly for higher cost floating storage. A sudden onslaught of crude held in floating storage dumped back into markets at a time when demand remains very vulnerable to lockdowns being reimposed could overwhelm markets and drag prices lower if the volumes are not staggered.

The US drilling rig count continues to bear the brunt of the adjustment in observable supply with another 34 rigs taken out of operation last week. A total of 425 rigs have now stopped working since mid-March while the total number of working rigs is lower than the trough hit in the 2015-16 adjustment to supply.