As of Tuesday, WTI Crude Oil was trading at $36.21 a barrel. While this may be 60% off the year’s starting price, it represents a 179% jump off last month’s low of $13 a barrel. So, what has changed in a month to effect such a dramatic rally? There are three main contributors:
The first is that, despite weak compliance from OPEC in May, the market anticipates that the OPEC+ coalition will extend the production cuts through July or August. According to the original agreement reached in April, OPEC+ was to cut 9.7 million barrels per day in combined production for two months — May and June — and then ease these to 7.7 million barrels per day, to stay in effect until the end of the year. Then, from January 2021, the production cuts would be further eased to 5.8 million barrels per day, to remain in effect until end-April 2022.
On Monday, reports emerged that the OPEC+ group could hold its June meeting this week, earlier than the initial plans to hold the teleconference on June 9 and 10. Russia reportedly doesn’t mind moving the meeting to this week — a sign that Moscow might agree to extending the current cuts beyond June.
The second reason is that, in the US, the oil rig count is falling at the fastest pace on record. From March 13th, the rig count was cut in half in just over six weeks and is now down 65% since that date. Bankruptcies in the US shale patch have risen. According to the Financial Times, since the start of the year, 17 companies have already filed for Chapter 11 protection. In addition, Rystad Energy estimates that as many as 73 shale drillers could be forced into bankruptcy by year’s end. The falling rig count indicates that future oil production in the US could be lower than it would have been if prices did not crash. It also means that the price decline is having a huge impact on current US production.
At the end of March, the US was producing 13.0 million barrels of oil per day. By mid-May, that had dropped to 11.5 million barrels — a 1.5 million barrel per day decline. The only other time the US has experienced a decline of this magnitude was after Hurricane Katrina, but production quickly returned to normal soon after. Even following the 2014 oil price crash, production only fell by 1.1 million barrels per day, and it took a year before production declined to that level.
Finally, the third factor that has helped prices rebound is that demand has started to recover. According to the Energy Information Administration (EIA), in early March US consumption of petroleum products had reached 21.9 million barrels per day. A month later, with most of the country under lockdown, demand had fallen to 13.8 million barrels per day. But, as some states have let stay-at-home orders expire, and as the traditional summer driving season approaches, demand has rebounded. By the second week of May, demand for petroleum products had climbed back above 16.5 million barrels per day. While well below normal demand, it represents a 20% rise off the lows.
Although these factors are specific to the US, it was the US that contributed the most to the oversupply in recent years. Additionally, a similar dynamic is playing out in many countries around the globe. So, while the oil industry still faces challenges in the face of weak demand, the worst could be behind us for now.
Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.
Rick Cloutier, PhD, CFA is the Chief Investment Strategist for Washington Trust Bank with over 25 years of portfolio management and investment experience. He is responsible for directing the portfolio management, research, and trading activities for the bank’s multi-asset class strategies. He is also responsible for overseeing the client portfolio manager team and portfolio analytics team. Rick has written numerous articles for Investopedia and wrote a weekly column for the Fall River Herald News in Massachusetts. His research has appeared in numerous journals, including the Journal of Investment Management and Financial Innovations, the Journal of Business Management and Economics, and the International Journal of Revenue Management. He provided a nightly commentary on WALE radio and authored the novel Caveat Emptor. Rick earned his BS from URI, MBA from Boston University and PhD from SMC University.