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Over the past six months, the overwhelming driver of the oil market has been the covid19 pandemic and its impact on demand. Global oil consumption appears to have dropped nearly 20% in the second quarter versus year earlier levels, the kind of change that was previously incomprehensible: it had been a century since a pandemic of similar impact had occurred, and the worst recessions typically reduced demand by single-digit percentages. The 1979 Iranian Oil Crisis did see a similar reduction but over a longer period, about three years. The figure below, showing quarter-on-quarter change, indicates that in the 3 rd and 4 th quarters, the enormous inventory build of the second quarter should be worked off.

The release of President Trump from the hospital after his infection saw a surge of optimism lift equities and oil prices, but concerns about future demand should not be dismissed. Certainly, it is the case that personal protection equipment, tests, and treatments have all improved from the dark days of early this spring, but the world has hardly conquered the virus. There is still no effective vaccine, tests do not prevent the disease, rather they detect it, and personal protection equipment that is not used is hardly effective.

Which demonstrates the importance of public attitudes and the danger of complacency. Countries like China and Germany managed the pandemic fairly well and appear now to have reduced the incidence of infection enough that they can control minor outbreaks through contact tracing. And with the northern hemisphere approaching flu season, there is hope that people will take enough precautions to reduce the incidence of both flu and covid19 that the spread of covid will not resurge.

On the other hand, there remains significant risk of a second wave (or wave 1.2). The return to school and colleges has already seen new outbreaks the severity of which is not clear yet. The vacation period in China could translate a new cluster, while some European countries are seeing cases surge as they loosen restrictions on work and leisure.

And public figures are often worsening matters by taking steps that suggest preventive measures are unnecessary, while concerns about vaccine safety are growing. Past fears of vaccines were unscientific but now, with talk of rushing approval of a covid19 vaccine, even those who oppose the anti-vaccine movement are expressing caution about taking a new vaccine if it appears to have been approved over the objections of the medical community.

In the U.S., the most positive sign has been the rapid response of the public to new surges by staying home more, as credit card and similar data show. But right now, monitoring economic and social behavior in the U.S., Spain, France and Britain to see if the second wave is choked off successfully will be crucial in demonstrating whether or not a new price collapse could occur.

The second quarter drop in oil demand of approximately 15 mb/d should not be repeated, in part because of better control of the virus in many places. An OECD-wide economic lockdown is very unlikely, but some slowing in consumption is nevertheless possible. The biggest threats are:

  1. A large outbreak in China, which requires a limited lockdown (unlikely);
  2. National outbreaks in Europe spreading to other countries, and requiring new restrictions (possible);
  3. Combined flu/covid outbreaks in a number of places that are large enough to stress medical care (possible); and/or
  4. U.S. outbreaks become persistent because of political resistance to precautions (all too possible).

It appears as if an outbreak that is widespread and serious enough to drop world oil demand more than a few million barrels a day is unlikely, however, given the very high global inventory levels, adding 50-100 million barrels to existing storage will provide at least some stress to the system but certainly increase the current, relatively small contango. Extra oil from Libya and Iran would be insult to the pandemic’s injury, but is unlikely on its own to crash the price. (The figure below shows OECD inventories through end-July, the latest available, although preliminary data suggests a decline in August.)

So, while a second wave of the pandemic should be much less stressful for oil prices, the market balance suggests, that we are months away from inventories returning to normal levels and it remains vital for OPEC+ to adhere to their quotas and possibly for the Saudis to take temporary cuts in response to new slowdowns in demand.

(Note that global inventories are not reported but are thought to be roughly twice OECD inventories.)

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