The Most Fragile Oil Price Rally In History

Yves here. As this article makes clear, the current optimism about oil prices is based on some remarkable assumptions about Covid, namely that the US has attained herd immunity by summer as Biden warns vaccinations won’t be complete by the end of 2020…even assuming the dogs eat the vaccine dog food.

I thought readers would find it instructive to read why we will be back to the old normal by summer. It must be nice to live in such a comforting bubble.

By Irina Slav, a writer for with over a decade of experience writing on the oil and gas industry. Originally published at OilPrice

Brent crude could hit $70 or even $80 a barrel by the end of this year, one hedge fund manager says. It could top $100 next year, an energy analyst forecasts. Oil is on a tear, and suddenly, everyone is bullish. But this is probably the most fragile oil price recovery in history. Something as tiny as a virus could kill it.

Herd immunity is the big factor for hedge funds, according to a recent Reuters report. According to them and several banks, the United States—the world’s biggest oil consumer—will reach herd immunity by the middle of the year, which will coincide with summer driving season to the benefit of oil producers.

“By the summer, the vaccine should be widely provided and just in time for summer travel and I think things are going to go gangbusters,” one hedge fund manager, David D. Tawil of Maglan Capital, told Reuters.

Government stimulus will also help. In fact, it could even push prices to $100 and over, according to Energy Aspects’ Amrita Sen.

“We’ve always called for $80 plus oil in 2022. Maybe that is $100 now given how much liquidity there is in the system. I wouldn’t rule that out,” Sen told Bloomberg this week.

Central banks and governments have been more than generous with stimulus to weather the effects of the crisis caused by the pandemic, and while some are skeptical about the long-term benefits of some measures, the overall sentiment towards them is positive.

There are some flies in the stimulus ointment, however. In Europe, some analysts are warning that government support for businesses is creating so-called zombie companies that will collapse the moment the stimulus end, which it will eventually have to do. In the United States, some analysts have questioned the need for President’s Biden $1.9-trillion stimulus program saying the economy is already picking up, however slowly, and a stimulus package as huge as this one could lead to excessive inflation, which could have unexpected consequences.

And then there are the oil producers, many of which have been struggling to stay afloat since the pandemic hit the global scene. With rising oil prices, the struggle will end, but it will also tempt many to start producing more, especially as demand recovers thanks to mass vaccinations.

This is the dominant expectation: that by the summer, there will be enough people vaccinated for life to begin to return to normal, including in oil demand. Analysts and financiers note that oil companies are much warier about production growth this time and will hold off returning to growth mode for longer. This may or may not be the case, but what most analysts and financiers seem to be brushing off is the possibility of a resurgence in Covid-19 infections.

It is not a thought many would readily entertain, not after the months of lockdowns and travel restrictions that decimated air travel and oil demand alike. Yet medical experts in senior positions such as the director of the U.S. Centers for Disease Control are warning that the new variants of the coronavirus that caused the pandemic could indeed lead to new spikes in infections. These variants appear to be spreading faster than the original virus, medics have said, but the bigger problem is that the vaccines we have available may not be effective against them.

“They’re more virulent, can cause more death, and some of them may even escape the immune response, whether it’s natural or from the vaccine,” said Dr. Celine Gounder, member of the Biden-Harris Transition Covid Advisory Board last week.

This is all it would take for bullish oil price forecasts to crash and burn: another resurgence in cases and the news that available vaccines don’t work against the new virus variants. It may well be this risk that is making producers so unusually wary about their return to production growth. This wariness, coupled with OPEC+’s continued cuts, would likely limit oil’s downside potential for a while, even if new Covid-19 cases do start to rise again in any of the biggest oil markets.

Interestingly enough, the hedge funds Reuters interviewed don’t seem to factor in the shift to renewable energy that is expected to depress oil demand permanently. On the contrary, despite many a government’s green transition plans, financiers expect a bright future for oil, not just this year and next.

“Oil companies, for the first time in a long time, are likely to make a big comeback,” Jean-Louis Le Mee, chief of hedge fund Westback Capital Management told Reuters. “We have all the ingredients for an extraordinary bull market in oil for the next few years.”

It is an interesting situation: governments and environmental groups are pushing for less oil and more renewables as soon as possible, touting the falling costs of solar and wind, and the breakthroughs in storage. Those who trade oil, on the other hand, expect a recovery in demand strong enough to lift prices to where they were before the pandemic and before the announcement of all these energy transition plans. It would be fascinating to watch who ends up correct.

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  1. PlutoniumKun

    I suspect a lot of those bullish hedge funds are engaging in a certain amount of pump and dump.

    Despite the catastrophic low prices, there is little evidence of wells having been abandoned or capped. This means that supply will almost certainly rise very rapidly in the event of any demand recovery. The only thing that could stop this is better relations between the Russians and Saudis to cooperate to keep a cap on supplies. But the probability is that so many companies and oil reliant countries will be desperate to grab market share and cash if prices go above $60 that we’ll see it choked off very quickly. Bear in mind of course that oil stocks are very high, so expect those to be run down first.

    China has also been very important in keeping demand high, but its demand has been almost entirely from the infrastructure sector – in other words, direct government investment – the evidence for a surge in consumer spending in China is very weak, to put it mildly.

    Even if – and its a very big if – vaccination goes swimmingly and the virus is on the wane by summer, its very hard to see a big surge in consumer travel. People make their decisions in winter and early spring, and I would guess that most people have planned a more local trip as a precaution. Many staff will still be working at home, a lot of big companies have already baked this into their 2021 work plans.

    It also should be noted that one reason for the relative recovery over the winter was very low temperatures over much of the northern hemisphere, this kept demand high for domestic and commercial heating. Coming into spring, we can expect this effect to wear off.

    I don’t know the situation in the US, but in Europe there seems to be a sea change occurring in the car market. Because its widely assumed that diesel will be phased out rapidly and EV’s will become dominant, people are reluctant to buy a new car. I’ve heard people who would normally be regular new car buyers say that they want to buy a good used diesel car to last for a few years until EV’s become cheaper. The indications are that this is hurting the car companies, and encouraging them to transition to EV’s even faster, as they now see them as the route to long term profitability.

    1. Thuto

      Could these hedge funds and their bullish predictions painting a rosy picture for the future of oil have anything to do with stemming the bankruptcy tide in the fracking industry? After all If the bulls say the oil sector is just about to turn a corner then the logic for creditors calling in non-performing loans en masse starts to look shaky.

      Additionally, the assumptions about vaccination look rather wobbly when one considers that here in South Africa the AstraZeneca vaccine has been shown to be ineffective against the dominant new variant that now accounts for over 90% of infections, to the point where we are apparently in discussions with several countries willing to take it off our hands. If the mutant strains do become dominant in other parts of the world, this whole thesis for the recovery of oil falls apart.

      1. ambrit

        Good point. There is such a thing as too tightly focused a vaccine. Could this be the “Achilles Heel” of mRNA vaccines?
        The more variants of the virus to appear, the harder it will be to vaccinate against effectively. [I mean, how many ‘variants’ of polio (3) or rubella (1) are there? Variants of the coronavirus version of the ‘common cold?’ (4).] Covid-19 so far, (3) and counting.

        1. marku52

          AZ is not one of the mRNA vaccines, it is one of the more traditional types, I think tied to an adenovirus.

          Not to say that the mRNA ones won’t have difficulty as well. It just depends on what pieces of the virus they are stimulating the immune system with, and whether that piece changed with the variant.

    2. Harry

      High enough oil prices will definitely prompt a lot of tight oil back on the market. But right now tight oil cant get hold of money. So there will be a lag. Plus the majors have been capital constrained for a while too. I would argue that there will be a delay between higher prices and rising supply. So yeah, $80 oil will bring on a lot of supply but that doesnt mean that it wont get to $80

      For what little my opinion is worth. But you made me think I should buy more SLB.

    3. Synoia

      Big Oil’s biggest enemy is Zoom

      That is: Zoom’s effects on the waste of money and productive time embedded in business travel.

  2. KD

    I am not convinced that the timing of COVID-19 herd immunity is the key to oil bulls. Right now, OPEC+ has in place significant production cuts and they could knock the price of oil down to negative $16 again if they wanted to, but if they maintain those cuts or ease them gently over time, demand is currently in excess of supply and the prices should remain stable, and current demand is based on the effects of existing COVID restrictions and if it moves, will likely move up unless there is some mutation that increase the death rates by 100X.

    My guess is that the longer COVID-19 suppresses demand, the higher the price extreme in oil prices. It takes enormous capital expenditures to maintain oil production, and everyone has just spent the last year drastically cutting their capex and therefore, their ability to maintain production levels. Much of the oil and gas companies have atrocious balance sheets, and are not going to be able to get financing until they clean them up, so free cash flow is likely to be directed at deleveraging over the next year, not maintaining production. Further, when there is significant capital again devoted to maintaining or increasing production, there will be a time delay between spending and actual production. When COVID clears, and air traffic moves back to the norm, it will create ~5% demand increase overnight, and oil prices will spike. The longer it takes, the longer the period of significant undercapitalization, the higher the spike. Not to mention reducing permitting on federal lands and blocking pipelines will only help drive up prices. My 2 cents.

    Its not some nefarious pump and dump on the part of the hedge funds, it is a bet based on the fundamentals of the oil markets. [Not going to address the renewables discussion, other than to say look at Germany and France in what they pay for electricity and greenhouse emissions, and look at California last summer. You have grifters and a lot of low information greens pushing renewables.]

    1. cojo

      You bring up some important points that were barely glanced in the article. OPEC+ looks like it has regained it’s status as the swing producer and will likely dictate where oil prices will go over the next few years… if they can hold it together.

      One other issue with US producers is the consolidation in the industry over the last year. This along with the lack of easy money will put a damper on the ramp up in production from higher oil prices. Fewer players will have less pressure to “drill, baby, drill” until they see the supply demand balance is on firmer ground.

  3. Tom Stone

    So many happy assumptions!
    Let me reboot my virtual can opener and take a look at one of them.
    Vaccine distribution.
    Here in California it is on a County basis, every County devised its own plan to distribute vaccines.
    My Sister and BIL are in Placer County, both between the ages of 65 and 70.
    They are scheduled to get their second dose (Pfizer) on the 16th.
    I’m in Sonoma County and my health provider will start accepting appointments on the 15th for those in my tier (1B).
    I know a 60 year old who is part of a different health care network, he had his first dose a week ago today.
    And my 19 year old Daughter Rosetta got her first dose yesterday.
    Her Fiancee’s Mother is a health care administrator.
    A few extra doses were available…

  4. shinola

    >”According to [hedge funds] and several banks, the United States—the world’s biggest oil consumer—will reach herd immunity by the middle of the year, which will coincide with summer driving season to the benefit of oil producers.”

    By the middle of THIS year? IMO, that seems overly optimistic, Pollyanna-ish even (but I would be glad to proven wrong)

    1. ambrit

      There is growing evidence that the Covid strains will never succumb to “herd immunity.”
      The constant mutations and changes, even though slight and subtle for each individual variant, in the virus are suggestive of the method that “common cold” coronaviruses employ to keep always one or two steps ahead of the yearly flu vaccines.
      (As always, I welcome correction by those with more experience in the field.)
      New Improved Covid is here to stay.
      Welcome to the ‘New Normal.’

      1. marku52

        Yes,it seems odd, early in the pandemic, everyone was saying that coronas mutate all the time, and so repeated vaccinations would be required, just like the flu. Then somehow, the idea got implanted that we would get vaccinated and get to herd immunity and it would all be over with.

        That doesn’t seem very likely. We probably will have much less severe disease and death with repeated exposure to covid21 and covid22, but it will still be a problem, and require repeated vaccinations to contain it.

        1. drumlin woodchuckles

          Teasing people with the fake concept ( as far as coronaviruses are concerned) of ” herd immunity” was designed to divert public attention away from the concept of exterminating this virus will it still is or was possible. The goal was to make the virus permanent in order to create a multi-billion-dollar-per-year vaccination opportunity every year for decades to come.

          Is it still pointful to regard virus-extermination as a worthy- goal IF societies can do all the needed things all at the same time to corner and exterminate the virus? If not, then the “herd immunity” bait-and-switch diversionists have done their cynical job and done it quite well.

  5. ambrit

    The “Biden-Harris Transition Covid Advisory Board??!!”
    Is this sort of Co-Emperors nomenclature common? I don’t seem to remember any Kennedy-Johnson anything.
    Who makes up and approves the names of governmental groups? Public Relations, (for the other side?)

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