KF Spotlight : WTI & Brent Crude Oil – YTD 2021 Market Recap

The Wrangle in in OPEC

In 2020, OPEC + countries agreed to reduce output by 10 mb/d from May 2020 to end of April 2022, to contain the price decline caused by falling demand. Now, with global demand reviving, Saudi Arabia has proposed that OPEC increase production by 2 mb/d between August 2021 to December 2021, but extend rest of the cuts until the end of 2022. But the UAE wants the production cuts to extend until end of 2022 only if the baseline for output is revised. OPEC members’ productions are linked to the baseline and this was to be revised at the end of the current production cut agreement, which was April 2022. Extending the cuts until end of next year would result in the UAE not being able to pump more oil, thus leading to under-utilisation of its production capacity.

While the supply situation is not unsalvageable, demand projections may need downward revision if the third wave or new variants of the virus cause further disruptions in global recovery. Also, the recovery is limited to advanced economies with most developing and under-developed nations yet to progress materially in vaccination. Global travel cannot revive under these conditions.

Crude Oil Historical Volatility

July’s OPEC+ announcements and heightened uncertainty in the COVID-19 outlook with rising cases of new viral variants have likely contributed to heightened uncertainty and price volatility. The 30-day historical volatility for WTI crude oil futures prices rose above 30% on July 19, and volatility for Brent crude oil followed suit. Both benchmarks had historical volatility less than 30% throughout June and most of May. As of August, WTI 30-day historical volatility was 38%, and Brent 30-day historical volatility was 36%, up 18 percentage points and 23 percentage points, respectively, compared with the beginning of July.

Demand – Supply Equation

Global demand for oil declined from 99.7 million barrels per day (mb/d) in 2019 to 91 mb/d in 2020 as the Covid-19 pandemic dealt a sharp blow. Travel and mobility were among the worst affected by the lockdowns, constricting petroleum consumption. With crude oil prices crashing, supplies were reduced in the second quarter of 2021, by both OPEC and non-OPEC producers.

The sharp rally in petroleum price in 2021 is due to two primary factors. One, the virus seems to have been contained quite effectively since the beginning of this year, especially in the OECD countries which account for around 47% of demand. The fast pace of vaccination has helped revive economic activity in these countries, leading to expectation of good demand for petroleum products. The IEA, in its June report, expects global oil demand to return to pre-pandemic levels by the end of 2022, rising 5.4 mb/d in 2021 and a further 3.1 mb/d in 2022.

Two, while demand is expected to revive, there are concerns over supply due to the ongoing stalemate between the UAE and the OPEC countries. According to the IEA, oil output from non-OPEC plus countries is set to rise in 2021. Given the projected demand of 96.4 mb/d in 2021, there could be an output gap this year, unless OPEC countries come to an agreement on increasing output.

Covid -19 Pandemic & The Economic Situation

While we do know how severely COVID-19 has affected public health and the global economy, the disease is a driver of global uncertainty and concern. While this kind of pandemic usually produces only a very short term economic impact, it can have some serious effects in particular areas of the economy. Because of the disease’s potential for further business disruption, the oil industry is concerned. If the outbreak is contained soon or turned into an endemic phase, we should be optimistic about how oil prices are going to respond but for now if the Delta variant continues to spread significantly globally, the demand for oil, and prices, will decline as travel and tourism are affected. For the oil business, that means a drop in jet fuel prices much greater than any decline in the price of gasoline.

Introduction of E-Mini WTI in CME

A factor to lookout for in the future in the introduction of the E-mini Crude oil futures contracts in July 2021 that are half the size of the full size WTI Crude Oil contract that consists of the West Texas Intermediate, (WTI) which has long been a benchmark for oil prices and has already traded over 50,000 contract since launching. This would allow traders to take advantage of the crude oil market with a lower margin requirement than the full size contract and its volatility, due to geopolitical, production and weather events allows traders to gain exposure in relatively straightforward manner compared to ETF counterparts. To add, trading in the e-mini contract will let traders to fine-tune their exposure and go short as easily as you can go long.