The GERM Report

-A growing number of voices are questioning this rally.

-Platts in a 2021 outlook say the future’s bright, but no need for shades just yet.

Vaccine and virus news giveth and taketh away. We saw Brent crude oil top $50 per barrel and later $51 per barrel in the previous session on positive developments for a vaccine for COVID-19. Reports of stricter lockdowns in the United States and Great Britain, however, bruised investor confidence on Friday. And while U.S. lawmakers were able to keep the government running for another week, the prospects of a stimulus remain slim. In the oil sector, an increase in rigs in the United States could be a sign of things to come. There seems to be a growing consensus that the rally in crude oil prices is looking a bit overblown.

It was a bit of a snooze-fest for commodities on Friday, with the headline writers leaning on the strength of the U.S. dollar to justify the moderate movements during the session. As of 2:45 p.m. ET, the price for Brent crude oil was up 0.44% to trade at $50.03 per barrel. For the week, Brent is on pace for a gain of 1.6%, less volatile than we expected.

Oilfield services company Baker Hughes reported Friday that rig activity in the United States increased by 12 to 258 this week, which combined with the four additions in gas rigs makes for the largest weekly increase since January. The developing trend in rig activity is supported by production figures, with the EIA reporting a 300,000 bpd increase from October production last month to reach 11.2 million bpd. A forecast for next year, published Friday by S&P Global Platts, estimates shale oil production, the one-time envy of the global energy sector, could decline by 1 million bpd next year given the slow recovery underway. But that may be dependent on the durability of a rally.

Asked by The GERM Report if the current price point was justified, Chris Midgley, the global head of analytics at the S&P Global Platts, said the fundamentals support a price for Brent that’s about $10 lower per barrel than it is right now.

“Absolutely, this is too fast too soon,” he said, but there is some Asian buying providing some support.

Prices will correct, he added, but it isn’t going to happen quickly. And if the market continues to overcook, it would incentivize shale production and add to an already-growing glut of oil.

Chinese independent refiners, the so-called teapots, are gobbling up crude oil given their new quotas. But we should expect this during the fourth quarter rather than read it as a signal for emerging demand. In India, refining capacity remains stagnant, suggesting demand there remains weakened by the pandemic.

Elsewhere, Midgley pointed to the “wave of optimism” spilling over the commodity markets from positive vaccine news. That news, however, is as fluid as the price of crude.

“While in the long-term we are more optimistic about a rebound of oil demand, causing us to upwardly revise our 2021 demand outlook, in the short term, we expect things to worsen, with increased second-wave lockdowns in the U.S. and Europe resulting in much weaker gasoline demand across the holiday season,” he said in a statement.

The new U.S. rigs, meanwhile, could be a problem once they enter into production. Drillers too may be clearing off the inventory of drilled, but uncompleted, wells given the gain in crude oil prices since early November, when Brent was trading closer to $38 per barrel.

That’s just one of the origins of emerging supply-side pressures. Real demand might not show up until mid-2021 once we reach a considerable level of vaccinations against COVID-19. But right now, we’re seeing Libya moving past the 1 million bpd and U.S. adversaries looking for a thaw in relations from President-elect Joe Biden in order to put more barrels on the water. Venezuela quite recently was still a major producer and could get some relief from crippling sanctions in a Biden administration. Iran, anticipating a return to the U.N.-backed nuclear agreement, is already ramping up output. China, Midgley reminded us, can access sanction-free Iranian oil because it’s not too exposed to the U.S. banking system.

Simply put, all these barrels are dressed up, but they may have no place to go.