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Revisions to Demand Recovery Estimates Could Weaken Spreads

Author: Brynne Kelly

On July 7, 2020 the EIA released it's Short-Term Energy Outlook (STEO). In it, they outlined their estimates for global petroleum (and other liquids) demand. Last Friday, Rystad Energy put out a revised estimate for global oil demand in which they stated:

"In this update, instead of gradually recovering monthly, global oil demand in our base case is now expected to stay relatively flat from July to October 2020 and then inch up again from November, albeit at a much slower rate than previously estimated. In July, oil demand is now expected to average 90.2 million barrels per day (bpd) and then improve to an average of 90.6 million bpd for August, September and October. In November, oil demand is likely to reach 93 million bpd and in December climb a bit more to 94.7 million bpd – still a far cry compared to the pre-Covid oil demand average level of more than 99 million bpd in 2019."

Both of the above-mentioned demand estimates are shown in the table below (columns 2 & 3). The EIA STEO's demand numbers include 'other liquids' and show 2019 average consumption of roughly 101 million barrels per day. Rystad uses a figure of 'more than 99 million bpd' for 2019 consumption. We assume the difference of roughly 1.5 million bpd is attributable to 'other liquids'. Keep that difference in mind when looking at the comparisons below.

If a reduced-demand scenario such as the one presented by Rystad were to materialize, the OPEC+ production cuts alone will fall short (last column, production cuts vs demand loss - negative number = production cuts < demand loss and vice versa). Currently, the OPEC+ production cut s are scheduled to decline by 2 million bpd on August 1 and again by another 2 million bpd by January, 2021. All else being equal, slowing the rate of demand recovery over the next 3 months could put significant pressure on short-term oil prices.

Steeper Contango

The first place we would look to see a slower demand recovery scenario play out is in the steepening of the slope of the futures curve. Indeed, while last week the 12 month WTI futures curve generally shifted up and down with the same overall shape, by Friday there was a noticeable increase in contango (purple line below).

Fall/Winter Spreads

Drilling down further, we use the Oct/Jan futures spread to narrate the slower recovery scenario (from table: Oct= supply greater than demand; Jan=demand greater than supply). This spread should capture the continued weight of inventory on the front of the curve and move lower (black dot=2020 Oct/Jan spread below).

Of course, spreads can't be taken out of context, storage levels must also be factored in. Looking at US EIA oil inventory from 2015-present, it's no surprise that there is a notable relationship between lower oil storage levels and a tighter Oct/Jan spread (pink and green dots above and below).

If demand were to stall for the next several months and oil storage to tread water at current levels, the deficit to prior year levels will begin to grow. As the Oct/Jan spread stands now, it seems to have been pricing in more of a 'V' recovery than a 'U' recovery. Under a slower recovery scenario, the only real risk we see to the Oct/Jan spread narrowing would be that caused by hurricane-induced short-term supply disruptions in the US. In the shale production era, hurricane-induced disruptions have generally impacted refiner through-put as much as or more than they have impacted production output.

Another potential weight on the front of the market comes from distillates.

Summer is typically the time of year that the US builds distillate (HO) inventory in anticipation of winter heating demand. Thanks to the virus, distillate inventories are at stratospheric levels (black line below) ahead of schedule.

Historically, the lower the distillate inventory going in to the winter, the tighter the Oct/Jan spread in HO futures (inventory above vs spreads in US$/bbl below). Of course as mentioned, October is highly vulnerable to hurricane-induced refinery disruptions (as seen in the 2017 spike due to Hurricane Harvey).

Given where the Oct/Jan spreads are in WTI and HO, there is bound to be a lot of volatility due to the fear of storm impacts and the uncertainty around recovery (either fast or slow). If the recovery is indeed 'stalling' or slowing, we will start to see lackluster inventory reports. Especially as we move into August.

Both the WTI and HO Oct/Jan spreads seemed to have stalled last week. We don't think it would take much to tip them over.

WTI in US$/bbl

HO in US$/bbl

Worth Mentioning: Winter gasoline spreads are less volatile.

Inventory has been less of a factor in the Oct/Jan spread in gasoline futures since gasoline demand in the winter is not as robust as in the summer and also since cheaper blending components can be used for winter RVP specifications.


As recovery estimates are revised, short-term spreads will become the target in the oil complex. Outright price levels have found no real direction and have been stuck in a range. The market needs spreads to tell the story.


Weekly Changes

The EIA reported a total petroleum inventory BUILD of 4.20_million barrels for the week ending July 17, 2020. Crude oil alone posted a weekly BUILD of 4.90 (excluding SPR).

Year-to-date, total Inventory additions stand at a BUILD of 160.60 million barrels (vs 156.40 last week).

Commercial Inventory levels of Crude Oil (ex-SPR) and Refined Products remain elevated compared to prior years, however gasoline comps show less disparity.


Lee Taylor - Technical Levels


Resistance: 44.01 / 45.18 / 46.34

Support: 41.98 / 39.70 / 36.49

Technically speaking, I feel as though the Brent market is the strongest commodity of the four. It was able to reduce the size of the gap in the weekly and daily September charts. A small gap remains between 44.89-45.18 in the weekly charts, however I have become less optimistic of its significance after witnessing what happened in September WTI. Oct/Nov Brent settled under -.34 which will now be resistance and support is -.60.


Resistance: 41.72 / 43.05 / 46.37

Support: 40.99 / 38.92 / 36.08

A little disappointing that September WTI was able to close the gap left from March’s collapse but did little else to follow through. This should be a rather interesting week as the market has traded sideways into the proverbial corner. The 50% retracement remains at 41.72, however, trendline support (beginning off the lows set in April) will come in at 40.99. I have been stating for weeks that until we fill these gaps, a bullish sentiment may not be fully embraced. If the market can hold the trendline, we may finally say goodbye to $40 crude oil.


Resistance: 1.2736 / 1.3090 / 1.3161

Support: 1.2307 / 1.2196 / 1.1957

Almost a repeat of the rest of the complex…a late week rally failed to produce any major moves to the upside. There are many gaps above the gasoline market found in the daily, continuous, and weekly charts. If the entire energy complex cannot muster a rally quick, a test of our downside objectives is likely as this sideways trend will not last long. My reasoning is that all four commodities have a strong trendlines that have formed since early May and are trading right against these lines.


Resistance: 1.2654 / 1.2771 / 1.3023

Support: 1.2534 / 1,2305 / 1.1851

September Heating Oil tried to rally late last week but failed to breech the beginning of the gap of 1.3023. This level will remain as the biggest resistance point for the next several weeks. Plenty of support below the market which begins at 1.2543. All four markets have rallied nicely since early May, however to rally back into pre-pandemic levels, the markets will need some fundamental support. Oct/Nov heating oil has major resistance at -130.

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