Oil: An Unfinished Story
Oil prices renewed decline this week, June WTI contract dropped by more than 15%, Brent fell by 7.5%. The market expects OPEC to start cutting production later this week. Given fragile state of the market, some countries decided to start cutting output ahead of the agreed date in the OPEC + pact, including Saudi Arabia. Although bringing forward production cuts should positively contribute to market recovery, short-term market sentiment is under the sway of both near-term fundamental imbalances (the unresolved problem of oil storage in Cushing, highly uncertain pace of demand recovery) and psychological factors (fear of being on wrong side, FOMO shorts)
Drilling activity in the United States declined last week, Baker Hughes reported, pointing to a reduction in the rig count by 60 to 378 units:
The number of oil rigs is quickly approaching the level that we observed in 2016. Since mid-March, the number of rigs has shrunk by almost 45%, which means an imminent coming decline in US output which should additionally ease supply pressure on the market.
Another important component of current expectations in the oil market is the information related to signs of demand recovery. The worst for global oil demand appears to be in the past and it is reasonable to assume that it is reflected in the price. Data on volumes of oil refining in China gives benign indication of a welcomed rebound. Independent refineries in Shandong province increased refining to record levels while the data from the analytical agency SCI99 shows that refinery capacity utilization last week increased to 72.67% (+ 0.71% compared to the previous week). However, more importantly, compared with February, capacity utilization increased by almost 30% (the lowest point in February was approximately 42%). This suggests that oil demand in China is growing at a relatively steady pace.
USA: Strange CAPEX Stability
Orders for durable goods fell 14.4% in March YoY, which seems to fit into the overall picture of the crisis and not particularly noteworthy information. However, one of the components of the indicator, namely, orders for capital goods excluding orders in the civil aviation sector, showed strange stability in March:
Not taking into the account distressing situation with Boeing (13 new orders and 295 canceled), it seems that firms in the US were in no hurry to cut investment plans in March, as can be seen from the stable dynamics of the red curve in the above chart. The change relative to March 2019 was + 0.1%, but strangely it wasn’t reflected in production surveys from ISM (49.1 points) or from the Philly Fed (-12.7 points in March). It was expected that the reading will print much lower at -6.0%.
The Fed is closely monitoring the dynamics of orders for capital goods, as it reflects the expectations of financial managers regarding future demand for their goods. Taking “forward-looking” information into the account helps the Fed to not be lost in policy responses solely to past events. It is likely that firms were not able to assess the full severity of the lockdown in March, but there is also a chance that impact of lockdowns may be somewhat overstated (if we assume that financial managers have more information than we do). In any case, a positive surprise creates the basis for less gloomy figures for the first quarter of GDP, which will be released next week.
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