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James Hyerczyk

U.S. West Texas Intermediate and international benchmark Brent crude oil futures finished higher last week as major producers began output cuts to offset a slump in fuel demand triggered by the coronavirus pandemic while data showed U.S. crude inventories grew less than expected.

The trading was a little different last week with many traders moving money out of the nearby June futures contract and spreading it around several deferred contracts in an effort to avoid getting caught on the wrong side of the expiring contract. Crude oil prices turned negative last month for the first time in history with the expiring May futures contract falling to minus $35.73 a barrel.

Last Week, July WTI crude oil settled at $22.29, up $1.07 or +5.04% and July Brent closed at $26.44, up $1.63 or +6.16%.

OPEC and Its Allies Begin Production Cuts

On May 1, OPEC and its allies, known as OPEC+, began its latest plan to take about 10 million barrels per day of oil off the market. This move is an ambitious start to regaining control of the oil supply and to stabilize prices, but it’s not enough given the size of the demand destruction. Furthermore, OPEC+ is going to need a tremendous amount of help from U.S. producers.

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API and EIA Reports Help Stabilize Prices

Storage concerns continue to weigh on markets with the International Energy Agency (IEA) warning that global capacity could reach its maximum by mid-June and that energy demand could slump by a record 6% in 2020 due to lockdowns. Nevertheless, WTI and Brent crude oil helped fuel a rally last week because of an easing of worries over rising U.S. stockpiles.

It started late Tuesday with the release of the American Petroleum Institute (API) weekly inventories report that showed a smaller than expected build, and continued on Wednesday when the U.S. Energy Information Administration (EIA) reported numbers below the forecasts.

Weekly Forecast

We won’t have enough confidence in the current rally until we start to see evidence of real buying. All we’re seeing is short-covering, but that’s the way bottoms are formed.

First, the shorts have to get taken out then there has to be a test of the bottom. If the bottom holds then this will signal the presence of new buyers. Based on past performance, it could take as many as five weeks to form a solid support base. Until then, don’t be surprised by volatile, two-sided trading.

The estimated shortfall this year is expected to be about 30 million bpd of demand. The impact of the coronavirus pandemic has obliterated demand with much of the world’s population still under some form of economic and social lockdown.

Gains are likely to be capped and selling pressure may resume over the short-run since the 30 million bpd plunge in demand is three times the size of the OPEC+ output cuts.

Prices could remain underpinned over the near-term, however, because of signs of a tightening of U.S. supply. Bullish traders and domestic oil companies are hoping this develops into a trend. Nonetheless, industry professionals would like to see more aggressive cuts in production by U.S. producers.

The smaller inventory builds should be noted but we’re going to need to see a continuation of this trend in the coming weeks to suggest the worst might be behind us. However, the reality is the already-stretched storage capacity is getting fuller and fuller every week, a rise in prices cannot be sustainable for long as the problem is not really resolved.

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