Oil prices lost some of their currency gains in yesterday’s late trading session and the trend continues this morning, with both Brent and WTI facing a modest decline.

It was expected that oil wouldn’t keep its level, which reached this week a multi-month high, and we pointed it out in yesterday’s comments.

Most news on fundamentals were signaling towards a bearish sentiment, which today has taken over the trading floor.

Smooth international trade relations are needed for oil demand to remain uninterrupted on the long term and tensions between the US and China are never a good sign. Closing consulates is a clear escalation and how this relationship develops is something to keep an eye on.

WTI may be negatively affected more than Brent as China is the key future home for excess US crude barrels once the US shale machine starts growing output again, from 2021 with higher oil prices.

Meanwhile, a second factor and no less important is how Covid-19 is expanding on the background. Infections keep on rising in the Americas, namely the US, but also in key markets in Asia. US pandemic deaths are also on back-to-back daily high levels and we are not anywhere close to a recovery there.

If a second wave fully materializes in the US, we estimate it will put a total of around 5 million bpd at risk at its peak at the end of August 2020.

We have already observed a surge of Covid-19 cases starting from late June. Up to date, 9 US states have already put some restrictions back on, closing bars and all entertainment venues, while 13 other states have now paused their opening process that would entail reopening of businesses and return of commuters on the roads.

We assume that states will tend to avoid imposing full stay-at-home orders, prioritizing targeted and local (county/city-level) policy responses.

After the exhaustion of a second wave, we estimate that around 10% of total oil demand will remain under various degrees of risk for the rest of the year, mainly due to international aviation restrictions and longer term behavioral and structural changes of oil products consumption.

While eyes are on Covid-19 infections, shut-in production in the US and elsewhere has started to be reactivated, also slightly pushing back the price growth we have observed during the last weeks.

Going forward and since the world is still trying to shrug off the Covid-19 pandemic, we don’t foresee oil prices moving much higher from where they are today this year. Oil demand will take much longer to recover than initially thought and any further price recovery would have to be artificial and a result of a surprise development on the supply side. That said, the next OPEC+ meeting is not far away and traders look forward to curtailment-compliance news, and also to indications about how the alliance sees the pandemic’s progress.

Lastly, on the bullish side today, Equinor posted 2Q earnings and a positive medium term outlook for oil prices. We agree that supply capacity in the medium term will be severely impacted by lack of field sanctioning in 2020/2021. The oil market has 14 million bpd of spare crude production capacity now due to OPEC+ cuts and beyond, but as demand is still 10 million bpd below the normal 100 million bpd, a return to normalcy during 2021 will deplete most of the spare capacity leaving oil prices vulnerable to upside shocks from 2022.

The positive surprise in the leading indicators for manufacturing and services sectors for July this morning, should be a positive for oil prices. To sustain the demand recovery, though, an uptick in activity must be followed by a recovery in job creation.