Oil Futures Lower as COVID Scrambles Demand Expectations

Brian L Milne
By  Brian L. Milne , DTN Refined Fuels Editor

CRANBURY, N.J. (DTN) -- Nearest delivered oil futures on the New York Mercantile Exchange and Brent crude on the Intercontinental Exchange moved lower early Tuesday, with oil prices to remain volatile as market participants realign demand projections as Asian economies highlighted by China contend with a spike in COVID-19 cases, will Eurozone and U.S. manufacturing sectors continued to register growth in July, albeit at a slower pace.

China has returned to citywide lockdowns in parts of the country where a highly contagious Delta variant of coronavirus has caused a surge in cases, with the spread of the virus moving inland from coastal regions. Most of China's confirmed cases have been reported from the Jiangsu province, where economic output was second largest in China behind Guangdong, while rising cases in the industrial city of Yangzhou where 5 million reside, factories and logistics firms have been shut.

Similar scenarios have played out in other Asian countries, including Vietnam, disrupting factory output and import-export activity at key ports for the world's supply chain. From late May to late June, operations at the Port of Yantian, China's largest container port, were reduced to about 30% capacity because of a jump in COVID-19 cases. The port has reportedly cleared the backlog, returning to full operations in late June, but now a backlog of vessels has been reported at U.S. ports, notably at the ports of Los Angeles and Long Beach, California. Supply chain issues have slowed economic growth, denying manufacturers timely receipt of raw materials and parts.

The United States reached a milestone this week, with the Centers for Disease Control and Prevention on Monday reporting 70% of adults having received at least one vaccination. Reports indicate states with low inoculation rates have recently seen a sharp pickup in people seeking the vaccine, with a similar development having taken place in Europe. Asian economies have seen a slow rollout of vaccines, while China's vaccines have proven to have low efficacy.

The latest wave of COVID-19 infections has shaken confidence in early year expectations for oil demand growth and raised the specter of additional waves of infections during the traditional flu season during the fall and winter months. Not only has the spike in new infections triggered lost factory output and supply chain disruptions while adding to labor challenges, but the evolving dynamic has also pushed back expectations for a sharp rise in international travel, capping jet fuel demand.

In their most recent Monthly Oil Market Report released July 15, the Organization of the Petroleum Exporting Countries projected world oil consumption would increase 2.92 million or 3.1% barrels per day (bpd) to 98.24 million bpd from the second quarter to the third quarter, and by another 1.6% to 99.82 million bpd in the fourth quarter.

The U.S. dollar weakened early Tuesday, holding above Friday's 91.780 one-month low, and the yield for 10-year Treasuries moved off 1.179% to 1.192%, as the market weighs future action by the Federal Reserve.

Fed Governor Christopher Waller told CNBC Monday the central bank could begin tapering bond purchases as early as October but added he would need to see strong employment gains of 800,000 or more for August and September before he would vote to tighten the Fed's accommodative monetary policy.

The Federal Reserve is purchasing $120 billion in bonds monthly, buying $80 billion of Treasuries and $40 billion in mortgage-backed securities, in addition to holding the federal funds rate between 0% and 0.25%.

Market expectations are for 900,000 jobs to have been created in July following job growth of 850,000 in June. Waller expects employment to grow at a quicker pace in the coming months as federal unemployment insurance atop of state insurance ends in September, having been deployed because of the pandemic. Waller said there is plenty of demand for job seekers.

Tapering could come at a quicker pace then the last time the Federal Reserve began tapering, gradually reducing monthly purchases by $10 billion. This time, Waller said the central bank would want to move much faster to be in a position to raise interest rates in 2022 should it have to because of inflation, although currently doesn't believe it will be necessary.

Waller reiterated a refrain from Fed chief Jerome Powell that the jump in inflation is transitory, expecting inflation to "cool off" later this year, although did point to anecdotal evidence that inflationary pressure might not be temporary. That evidence is businesses have the ability to pass higher costs through to customers, and will, having pricing power for the first time in a decade.

In early trading, NYMEX September West Texas Intermediate futures broke below $70 to $69.85 per barrel (bbl), and ICE October Brent was more than $1 lower at $71.75 bbl. NYMEX September RBOB futures were down 2.25 cents at $2.2525 gallon, and the September ULSD contract was down 2.3 cents near $2.1095 gallon.

Brian L. Milne can be reached at brian.milne@dtn.com

Brian Milne