Why is oil bouncing back?

Commodities Jun 5, 2020 / Reading Time: 2 mins
By Aditya Kapdi Reading Time: 2 mins

Oil prices have rebounded substantially since their deep dive into negative territory in April. The May contract settled at -$37.63 and prices of the June contract dipped to $10 per barrel. Since then, oil prices steadily gained strength throughout the last month with Brent oil rising above $40 per barrel and West Texas Intermediate trading around $37 per barrel. This recovery in prices comes as analysts anticipate crude producers such as Russia and Saudi Arabia to extend their historic deal to decrease crude output to address the energy sector’s longer-term outlook.

The current situation

On Thursday, members of the OPEC+ group are expected to hold an online meeting to deliberate on the production cuts. The current cuts of 9.7 million barrels per day have provided a guidance for June, but the upcoming meeting may see output bring reduced for an extended period of time. Russia’s initial rejection of the proposed output cuts in March led to a surplus supply of oil which sent the prices of oil to historic lows. Now, the budget boost gives the Russian President, Vladimir Putin, an incentive to comply with OPEC+ cuts which as shown recently have translated to higher prices. The implication of the higher prices means that the Russian government does not have to resort to selling a vast proportion of its foreign-currency reserves to strengthen the ruble. That being said, Russia and several other members of OPEC+ are pushing for only a one-month extension on cuts whereas the leading member Saudi Arabia is seeking a three-month extension. Analysts are considering the ramifications of the varying extension in cuts as output cuts of two or three months could see prices of crude add to their recent gains but a one-month extension may not be a strong enough catalyst to elicit a positive response in prices.

The future of oil?

The outlook for oil seems to be recovering after its poor performance during March and April and is further strengthened by an increase in demand from China. More than two dozen tankers are awaiting discharge at terminals on China’s east coast as the country leads the recovery in oil consumption. The demand in China for the month of May is almost at pre-COVID levels as refineries increase their operations to produce gasoline and diesel as factories and industries resume their businesses. This increase in demand, in conjunction with economies opening up again, adds to the positive sentiments for both WTI and Brent crude as front-month contracts trade at their highest levels since March 6.