Asia Oil: Oil stands out in a sea of green

"Even although we traded above CO1$46 overnight, the risk/reward still seems skewed to the downside in the near term, with supply and demand factors both potentially weighing on oil in the coming weeks. The direction for oil in 2H will depend mainly on the willingness of traders to look through the short-term supply and demand uncertainty as gasoline demand has ground to a halt for now, and the summer season driving clock is ticking.

But in this environment, traders may be content to focus on the ongoing market rebalancing. The recent surge in virus cases and the reimposition of some virus control measures will moderately slow the economic recovery in the near term but expect the recovery to get back on track in September, assuming virus developments don't prompt the reimposition of widespread lockdown. But ultimately, traders will continue to train their eyes on the ultimate vaccine prize."

At one stage last night, my trading screen was awash of with green – except for the dollar, of course – but oil prices stood out as the most curious among all after gushing to a five-month high with Brent chart-topping in at $46.23 per barrel. The weaker dollar certainly offered a reliable lending hand.

The oil market continues to find support from strength in the broader markets, with the S&P nudging higher again. And Crude stocks fell 7.4Mb, bullish vs. consensus for a -3.0Mb draw but below the -8.6Mb draw reported by the API Tuesday.

OK, I get it: the dollar is weaker, and since oil is priced in dollars that’s good for oil, and those in the US unemployment line will surely be guaranteed their employment stipend on a retroactive basis. But, right now, top lawmakers remain nowhere close to an agreement for a new economic rescue package, with disputes over funding the United States Postal Service added to the laundry list of bipartisan squabble. Then again, the political discord in Washington is oddly helping oil's cause these days due to the growing disdain for the US dollar. 

Still, I need to continually remind myself that history teaches that it’s unwise to craft a narrative to rationalize August's market behavior. Again, I think there was enough under the hood for markets to test the top end of the range this week – a jobless recovery notwithstanding. 

Many of the overnight headlines regarding the US risk centered on talks, be they fiscal negotiations or US-China trade talks, but what the market cares about is action. 

On the fiscal front, amid the stammering progress, there’s light at the end of the tunnel as White House negotiators said they aim to reach a deal on a new coronavirus-relief package by the end of the week. On the trade front, US and China trade officials will hold virtual talks on 15 August as part of the trade deal's review process. The talks come at a time when China's pace of energy imports from the US is falling well short of that required to hit the targets set in the deal. 

However, it doesn’t appear that the US is seeking to increase pressure on this front. USTR Lighthizer said China has made "significant purchases over the course of the last many weeks." (Bloomberg). The multiple headlines did not negatively shift the key trade war bellwether Yuan. The Yuan rallied, which is a favorable signpost for risk assets and oil. Indeed, removing the trade war risk is ultimately beneficial for oil prices. 

So far, cyclical economic data indicates that the coronavirus-related economic slump appears less acute than expected as the world economy continues to recover rapidly from the coronacrisis, which is favorable for oil. At the same time, rising OPEC+ and US production still represent a near-term threat to the view. But with at least the OPEC+ side of the supply equation well understood, investors may feel supply risks are already priced in. All the while, oil investors keep their eyes on the prize, which is a vaccine, of course, as there’s a good chance that we’ll be on the verge of approval of a COVID vaccine before the years out. 

Did stops play a role last night? The break of Brent $45.50, and the rapid ascent above $46, suggests there was some pain along the way. Frankly, I don't think anyone on the street, including the most ardent oil bulls, thought oil would rally this week with OPEC supply returning and blending with the continued negative economic impact of Covid-19 lockdowns and the fear of the virus hampering what should be a consumer lead recovery.

Overnight the EIA confirmed the API survey data as crude inventories decreased for the second consecutive week – they’re now down bullishly 18mb in two weeks and, thankfully, the industry is starting to show a clear downward trend. 

However, providing the poor optics and capping last night's scintillating and profoundly unforeseen oil rally is the glaring issue that product stocks are still building – total product stocks are up to 129mb (16%) since March and distillate stocks up 56mb (45%) over the same period. Indeed, gasoline demand has all but hit a brick wall as demand has ground to a halt for now. 

When all ofthis is combined, commercial inventories are not showing a decisive downtrend that does not support the current bullish price narrative as total stocks have only declined by 0.6% over the past two weeks.

While it remains clear, the worst-case scenarios from 2Q have been ruled out. Still, the skies are not entirely blue, and a shortage of contrails reminds us that a significant product demand is absent as airline fleets around the world remain grounded and jet fuel demand remains exceptionally depressed.