SINGAPORE (Apr 24): The once-invincible black gold made history this week when it crashed into negative price territory, as sellers frantically signal that they are willing to pay buyers to rid themselves of the commodity on which kingdoms were built and wars fought.
On April 20, West Texas Intermediate (WTI) crude — the US benchmark — dropped well below zero to as low as –US$37.63/barrel for May futures.
As the Covid-19 pandemic continues to bring about lockdowns and destroy demand for transportation fuel, analysts believe that oil prices are likely to remain under pressure for the rest of 1HFY2020.
Beyond the short-term extreme volatility, Tan Min Lan, Asia-Pacific head of UBS Wealth Management’s chief investment office, expects oil to languish at US$20 ($28.50) per barrel this quarter.
Although the Opec+ members are likely to act to stem further price drops via production cuts, it will be too little, too late, to get out of the glut. “Demand has completely cratered because of the global standstill that we’re in,” Tan tells The Edge Singapore.
“An agreement by Opec members and other oil majors to cut around 10% of global supply will only take effect in May and is likely too small to offset the roughly 20% decline in demand resulting from Covid-19-related economic restrictions,” she adds.
Between now and then, oil inventory can only keep piling up. What oil producers can do now is to try and be more efficient, as they face growing costs.
“Storage capacity in terms of oil tanks and pipelines are now reaching their limits,” says Tan. “What this means is that prices will have to keep falling to force the closures of less efficient producers in North and South America,” she adds.
For the coming year, Tan says that sharp production cuts are in order, not just by big players such as the Opec+, but also by smaller producers who are unable to survive.
“If you look through the history of oil, we’ve never had this kind of coordinated demand and supply shock of this nature,” says Virendra Chauhan, senior analyst at Energy Aspects. “It is difficult to say whether it’s the end, but it’s going to be a very, very difficult period for producers for the foreseeable future.”
“It is time to throw old perceptions of physical laws to the side and be prepared for more surprises in this broken oil market,” warns Bjornar Tonhaugen, head of oil markets at Rystad Energy. “Prices can go to unprecedented low levels. Unless there are further cuts announced, storage capacity will just not be enough.”
For the oil industry, the boom years just over a decade ago is but a distant memory.
There were already five tough years and the industry was still only “getting back to its knees” when the Covid-19 hit. As a result, in the past month, planned capex totalling some US$100 billion, spanning upstream, midstream and downstream, is put on hold, estimates Chauhan. “Producers are just looking to preserve cash. There’s going to be ramifications across the industry — everything, everything, will be impacted,” he adds.
However, other analysts remind investors to make a clear distinction between the futures trading market versus the real physical market. Taras Shumelda, portfolio manager at PineBridge Investments, observes that the US has a very active crude oil futures trading market. Between 60% and 90% of the contracts are traded by financial institutions, instead of real oil industry players.
As such physical delivery is rarely enforced by either buyers, or sellers. “Theoretically, if one had spare storage, a buyer could get the total amount of crude in these contracts while also being paid $29 per barrel. Whoever said “you can’t get something for nothing” may not have envisioned this scenario, says Shumelda.
Volatility priced in
In any case, along with an expected loosening of travel restrictions, demand for oil should recover somewhat in 3Q this year. “It won’t pick up to where it was pre-crisis, but it is going to pick up quite a bit relative to where we are today,” says Tan of UBS, who is expecting US$43 per barrel by end of the year.
“While the market is heavily oversupplied this quarter, we expect it to move toward balance next quarter and become undersupplied in 4Q this year,” she says.
Besides the return of demand, production shut-ins in North and South America will likely lead to a decline in global oil supply toward the end of the year, she adds.
If there is any good news, Tan believes that oil markets’ doldrums are unlikely to cause further inflections in the equity, fixed income and foreign exchange markets, as the bleak outlook has already been more or less priced in. “In our view, credit and equity markets had already moved to price in a weaker outlook for oil prior to this week’s disruption.
As such, we believe the broader fallout on credit and equity markets is likely to be contained,” says Tan.
According to her, the recent period of “extreme dislocation” in the US oil market ought to pass in 3Q, and as such, investors can take comfort in the fact that volatility in the oil market is unlikely to derail the medium-term credit outlook.
“While lower oil prices can have negative spillovers for sectors that rely on energy capital spending, such as industrials and chemicals, or markets with a high weight to energy, such as the UK at 13% and Canada at around 18%, net energy-consuming sectors and countries benefit from lower bills,” shares Tan.
“As such, we think the impact of oil prices on broader equity markets is likely to be relatively small, and likely eclipsed by developments in addressing the Covid-19 pandemic,” she adds.
