A timeline that explains the catastrophe in the oil market
How can the oil price fall into negative territory? What does it mean for the global economy and can the price recover? Who will benefit and will the oil market ever get back to normal? These are the questions that are front and centre at the moment, we aim to write the simplest, most easy to understand timeline to help those trading oil to understand what is going on, and what “normal” for the oil industry looks like.
Geopolitics
Oil is a geopolitical game, as such it can get caught in the middle when geopolitics get stormy. In 2020 two things caused the perfect storm for the oil price: 1, the coronavirus pandemic and 2, a damaging row between Russia and Saudi Arabia, which started in February and led to Saudi Arabia undercutting the price of oil sold by European producers by $6-$8 per barrel. At the end of February this caused major ructions in the oil price, with the price of Brent crude oil dropping $25 per barrel between 20thFeb and 9thMarch.
Saudi Arabia and Russia reached a truce at an unscheduled Optec meeting on April 9th, but this was too late to undo the damage done to the oil price.
The covid-19 pandemic
This has impacted the oil price in three main ways: 1, it has led to production cuts from some of the major oil producing nations; 2, it has led to a major cut in demand as global economies are artificially supressed with lockdowns to combat the coronavirus pandemic. Even when lockdowns are eased, there is a fear that economic activity could be supressed until there is a vaccine available to create herd immunity; 3, it has led to a massive increase in oil producers looking to store their oil since they cannot sell it, which has led to a surge in the price of oil storage facilities. In February it cost approx. $20,000 to rent an oil super tanker per day, that surged to $200,000-$300,000 in March. A record amount of oil is now being stored in oil tankers at sea, there are currently 160mn barrels of oil floating on the world’s oceans, which is significantly higher than the previous record of 100mn barrels in 2009.
While there is some hope that once lockdowns are lifted around the world demand for oil will increase, however, with the supply glut at record levels it could take time for the oil price to pick up.
Oil and negative prices:
‘The oil price is negative’ is misleading. The WTI oil futures contract for May expired in negative territory, but the benchmark for WTI and Brent crude oil is still in positive territory, although prices have fallen sharply since February. Added to this, prices for oil futures that expire in all future months are in positive territory. This is significant, the June contract, which has also sold off sharply in recent days is currently trading around $14 per barrel, which is up nearly 30% so far on Wednesday. This contract is likely to remain extremely volatile, for example, the jump in price on Wednesday may be linked to the news that US President Trump has ordered the US military to shoot down and destroy any Iranian vessels that harass US navy ships at sea.
Thus, one crude future does not a trend in prices make. We doubt that oil futures will continue to expire in negative territory for a few reasons: 1, as each month goes by the world gets closer to the end of lockdown and economic suppression, which will stop the oil price from falling into negative territory as future oil demand is almost certain to pick up in the future; 2, other things outside of coronavirus will impact the oil price; for example if the US military does shoot at an Iranian ship then we would expect the price of oil to jump significantly. All of this is currently being priced into oil futures contracts, for example the WTI futures contract for September is trading at approx. $26.30. Thus, the May futures contract may be a one off, unless we see lockdowns increase in duration passed May/ June, in which case we could see significant downward pressure on the June and July futures contracts, particularly in WTI, in the coming months.
What next for the oil industry?
This is a grim time to be an oil producer. Here are our views on how the collapse in the oil price could impact financial markets:
· Stocks:oil companies such as BP, Shell and Exxon have not traded lockstep with the price of oil, and they actually rose as the May WTI futures contract slipped into negative territory earlier this week. It will be a tough time for oil producers in the coming months, so we expect any recovery to be limited. However, in the long term, with oil prices this low it is hard to see how global economies will move away from carbon fuels in the coming years, which may benefit the oil majors, although we wouldn’t bank on strong dividend yields in 2021.
· Currencies:commodity currencies including the AUD, NZD and Canadian dollar have all been under downward pressure in recent weeks. The CAD is the worst performer out of this commodity bloc so far this week, mostly because of its strong links to US oil. going forward we prefer the Aussie and the Kiwi, which may benefit from the opening up of the Chinese economy, compared to the CAD, which may remain under pressure if WTI continues to sell off.
· Producer countries:many producer countries cannot balance their budgets with the oil price at this low level. Russia and Saudi Arabia have a breakeven oil price of $40 and $85 respectively. If the collapse in the oil price causes an economic crisis in a main oil producing nation then not only would it be negative for those countries’ currencies (the Russian Ruble is close to a record low vs. the USD), but it could spook financial markets more broadly and lead to risk aversion. Thus, where the oil price goes next matters for most financial markets, and not just the energy market.
We hope that this guide helps you to better understand the oil market. The negative price for the WTI May futures contract may be an anomaly, but the price of oil could stay weak for some time and that may have a broad impact on financial markets.