By Ole Hansen, Head of Commodity Strategy Saxo Bank

Crude oil's rally to the highest levels since early March has paused with the technical outlook beginning to look more challenging. The attention has for now turned from OPEC+ and successful production cuts to concerns that a renewed spike in COVID-19 cases may slow the process towards a further recovery in global demand. On tap today we have EIA's weekly inventory report at 14:30 GMT.

What is our trading focus?
OILUKAUG20 – Brent Crude Oil (August)
OILUSAUG20 – WTI Crude Oil (August)
XOP:arcx – Oil & Gas Exploration & Production
XLE:arcx – Energy Select Sector SPDR Fund (Large-cap US energy stocks)

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Crude oil’s latest run up to the highest levels since March 8 - when Saudi Arabia initiated its short-lived price war - has paused. Instead of focusing on the OPEC+ successful efforts to support the market through lower supply, the market has instead, for now, turned its attention to today’s U.S. stockpiles report and concerns that a renewed spike in COVID-19 may slow the process towards a further recovery in global demand. This ahead of the peak season for gasoline demand during the annual holiday season.
Since the April low WTI crude oil has been trading within a rising wedge formation, currently between $42.20/b and $37.70/b. The resistance level also ties in with the price required to close the gap that opened up following the March 8 price war declaration. On Tuesday the price temporarily retraced more than 50% of the January to April sell-off but failed to close above. At this stage we view the short-term risk as being skewed towards a high volume breakout of the lower trend line than a continuation.
 

Source: Saxo Bank
Several media reports from the past couple of days have also begun to sow some doubt about how much longer the rising demand-led rally narrative can be sustained. A renewed surge in COVID-19 cases in the U.S., an out of control situation in other countries combined with the recent scare in Beijing all very clearly highlighting that the invisible enemy has not yet been defeated. And while governments will use lockdowns measures as a very last resort due to the destructive impact on already reeling economies, these developments may still impact how we collectively behave in the public space.

Reuters: China hits brakes on crude imports after buying frenzy

WSJ (Paywall): Petroleum Refiners Pose Hurdle to Oil’s Recovery

Reuters: India's oil imports in May sink to lowest in over eight years: trade

Reuters report that China is likely to see a slowdown in the record pace of crude oil imports witnessed during the second quarter. Strong demand from independent refineries are likely to slow on a combination of storage facilities filling up with cheap crude oil, the recent rally in Brent crude oil back above $40/b and not least the prospect for fuel demand, following the latest outbreak in Beijing, being exposed to a second wave of lockdowns.

If confirmed the slowdown in demand is going to occur just as the current OPEC+ deal to curb production expires. A prolonged period of keeping production low are likely to challenge to the individual resolve of members of the group, some of which are desperate to increase production and revenues.
In the U.S. meanwhile the WSJ reports that refineries are struggling to make ends meet due to weak margins. The so-called 321 crack spread which reflects the profitability of refining three barrels of WTI crude oil into two barrels of gasoline and one barrel of ULSD (ultra-low-sulfur diesel) currently trades around $13/b, almost one-third below the seasonal average price. Weak profitability due to weak demand could drive lower output in order to avoid a further spike in fuel stocks.

The consequence being lower demand for crude oil and with that rising stock levels, not least considering the prospect of U.S. oil producers beginning to increase production. A development that can only be solved either by lower crude oil prices and/or stronger demand. The latter potentially not happening anytime soon with the pandemic refusing to loosen its grip. The article finish with this warning from Energy Aspect: “If summer fuel demand falls short of expectations, refiners will sell crude they bought in anticipation of a recovery”.

Finally the impact of a slower-than-expected pickup in demand is also being felt in India. Just like China, refineries have taken advantage of low prices and during April filled their tanks. While a pickup in fuel demand is expected over the coming months the pandemic’s grip on the economy cannot be ignored and may slow that process and with that demand from one of the world’s top importers.

Later today at 14:30 GMT the U.S. Energy Information Administration will publish its “Weekly Petroleum Status Report” or in short, its stockpile report. The American Petroleum Institute last night published a mixed report with crude oil stocks rising to another record while product stocks both fell.
 
While crude oil is expected climb and reach a new record around 540 million barrels, the market will also be looking for a rebound in production. This following last week’s big 0.6 million barrel/day drop, that was partly due to the passage of Tropical Storm Cristobal, which forced a lot of producers to shut output in the Gulf of Mexico.

Staying on the refinery subject the market, apart from looking for a drop in gasoline and distillate stocks will also be expecting another pickup in demand for both fuels. Last week the implied demand (4-week average) for gasoline and distillates trailed the five-year average by 1.5 million barrels/day and 0.7 million barrels/day respectively.