In this week's oil industry insider report, we will be looking at some of the most important oil market movers and how they influence oil prices. We will also have a look at the recent changes in the oil market fundamentals, and how they point toward oil market balance.
We will then look at the current events and developments taking place in the oil industry and we will end the report with an answer to the question "is there still any hope for a successful meeting in Doha?"
Oil prices fell sharply to one-month low this Monday as investors doubted the possibility of a successful output freeze meeting in Doha, Qatar following the comments from Prince Mohammed Bin Salman that Saudi Arabia will not freeze output without Iran and other major producers doing so. Another factor that has contributed to the sharp fall in oil prices this week was a stronger than expected U.S. jobs report which raises the prospects of interest rate rise. Brent crude fell 2.5 percent to $37.69 a barrel, and U.S. crude settled down $1.09 or nearly 3 percent, at $35.70 a barrel.
Fortunately, the fall in oil prices didn’t continue further through the week. And despite the decision of Saudi Arabia to freeze oil output only if Iran does too, on Tuesday, oil prices edged up on Kuwait's insistence that major oil producers will agree to freeze output with or without Iran's participation. While the gains in crude prices were limited at first as traders awaited U.S. oil inventories data which analysts polled by Reuters expected to have risen by 3.2 million barrels, it then jumped 5 percent on Wednesday as a result of a surprise decrease in U.S. crude stockpiles.
According to the Energy Information Administration, U.S. crude oil inventories decreased by 4.9 million barrels from the previous week at At 529.9. While the EIA report contained some bearish data such as a sudden increase in gasoline stockpiles, traders -who are looking for any spark of hope- chose to focus on the bullish side of the report. This is an important point that we should be looking at, which represents the current emotional state in the oil market.
A state where traders are more focused on the positive aspects of the oil market despite some bearish sentiments. It is an emotional state where hope is more dominant than desperation and depression. Understating the current emotional state of market analysts, traders and speculators helps to understand what influence their decisions and better figure out the near term trends in the oil market.
Technically, the unexpected fall in U.S. stockpiles signaled an important shift in the fundamentals of oil market. Supported by a continuous fall in U.S. oil production and rig count, the fall in U.S. stockpiles if continued, it will not only prevent the market from going lower in the near term but also it will sustain the oil prices rally and gives it a momentum.
Based on Baker Hughes rig count data, it is definitely obvious that U.S. rig count roller-coaster is still on the run. U.S. rig count was down 14 at 450 for the week of April 1, 2016. The number of rotary rigs for oil was down 10 at 362 and the number of rig count for gas was down 4 at 88. U.S. rig count is at its lowest level since Baker Hughes started its rig count service in 1944. In a similar trend, the international rig count was down 33 at 985 on March 2016 according to the Baker Hughes rig count service.
The number of rig count will still experience a falling trend at least for a few weeks from now as the oil market is in a critical time in which more decrease in rig count and oil production is needed to create the balance in supply and demand. While rig count has decreased sharply in the past months, the use of new and advanced technology and improved efficiency enabled oil companies to offset the impact of falling rig count on oil production.
Oil Supply & Demand
In terms of oil supply, a notable addition of oil into the international market came from Iran. According to its oil minister, Iran increased its oil and condensate exports by 250,000 barrels per day in March. The country is determined not to participate in the coming oil output freeze deal until its exports reach to pre-sanctions levels. This means adding around 1 million barrel per day to its export total.
While such news could drive oil prices down giving the fact that the oil market is still oversupplied, we don’t see much negative impact for it in the oil market. This is happening due to three reasons.
First of all, Iran is trying to gain back its own position in the oi market. A position that was filled by other producers who are supposed to cut back their outputs after the return of Iran into the international oil market. The second reason lays on the fact that the oil market is more concerned and focused on Doha's meeting to the point that other events taking place in the oil market are not given much attention. The last and most important reason is the fact that the intensity of fundamentals pointing toward oil market balance is increasing as shale oil production continues to fall, and signs of growing demand are becoming more obvious.
In the demand side, more positive signs of growing oil demand are appearing. A bullish outlook for the oil markets that was issued by the investment bank Credit Suisse which stated that oil demand is alive and well. In general, oil demand is correlated with the industrial demand. As industrial demand is slow and global economy is very fragile, demand for oil is less. But Credit Suisse pointed out to emerging market middle classes that are well and consequently fueling consumption of oil as they buy new vehicles.
Based on the Credit Suisse outlook, oil demand should continue to outperform the long existed historic correlation with industrial production. They expect oil prices to hit $50 as soon as May and demand continues to grow at more than 2 percent on an annual basis.
Answer to Question of The Week
The bad luck of the oil industry lays on the fact that politics and immature politicians still play a huge role in setting the direction of the industry. Doha's OPEC and non-OPEC producers meeting is a simple example. The outcomes of the meeting and hence the end of the oil market downturn depends entirely on the decision of few producers who may or may not agree depending on what they see fit their geopolitical agenda.
While many have seen the recent decision of Saudi Arabia not to freeze oil production unless does too as a move against Iran, I don’t see it that way. In fact, if Saudi Arabia meant that move against Iran, it would have done it during February's meeting.
Saudi Arabia's main aim is squeezing shale oil producers out of the market. When it agreed to freeze its oil output during February's meeting, it was to prevent oil prices from falling further. And when it did, oil prices rebounded to $40 a barrel level, and many in the oil market expected more. But that is not what Saudi Arabia wants, because their market share war against shale oil producers didn’t really achieve its goals. Shale oil producers are still producing and their production is not decreasing as Saudi Arabia expected.
If Saudi Arabia agreed on freezing output on April 17's meeting, it would give a positive push to oil prices to go up to $50 a barrel, and that will give shale oil producers something to hold on for as it means the worse is over. That is not what Saudi Arabia wants.
I don’t expect the meeting to be successful and even if it did and Saudi Arabia changed its mind, I don’t expect the producers to hold on to the agreement. There will be some disturbance in order to keep oil prices at low levels at least above $35 a barrel for the near term in order to force many more of shale oil producers out of the market.
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Source: U.S. Energy Information Administration, based on Bloomberg L.P. data
Note: All prices except West Texas Intermediate (Cushing) are spot prices.
The New York Mercantile Exchange (NYMEX) front-month futures contract for West Texas Intermediate (WTI), the most heavily used crude oil price benchmark in North America, saw its largest and swiftest decline ever on April 20, 2020, dropping as low as -$40.32 per barrel (b) during intraday trading before closing at -$37.63/b. Prices have since recovered, and even though the market event proved short-lived, the incident is useful for highlighting the interconnectedness of the wider North American crude oil market.
Changes in the NYMEX WTI price can affect other price markers across North America because of physical market linkages such as pipelines—as with the WTI Midland price—or because a specific price is based on a formula—as with the Maya crude oil price. This interconnectedness led other North American crude oil spot price markers to also fall below zero on April 20, including WTI Midland, Mars, West Texas Sour (WTS), and Bakken Clearbrook. However, the usefulness of the NYMEX WTI to crude oil market participants as a reference price is limited by several factors.
Source: U.S. Energy Information Administration
First, NYMEX WTI is geographically specific because it is physically redeemed (or settled) at storage facilities located in Cushing, Oklahoma, and so it is influenced by events that may not reflect the wider market. The April 20 WTI price decline was driven in part by a local deficit of uncommitted crude oil storage capacity in Cushing. Similarly, while the price of the Bakken Guernsey marker declined to -$38.63/b, the price of Louisiana Light Sweet—a chemically comparable crude oil—decreased to $13.37/b.
Second, NYMEX WTI is chemically specific, meaning to be graded as WTI by NYMEX, a crude oil must fall within the acceptable ranges of 12 different physical characteristics such as density, sulfur content, acidity, and purity. NYMEX WTI can therefore be unsuitable as a price for crude oils with characteristics outside these specific ranges.
Finally, NYMEX WTI is time specific. As a futures contract, the price of a NYMEX WTI contract is the price to deliver 1,000 barrels of crude oil within a specific month in the future (typically at least 10 days). The last day of trading for the May 2020 contract, for instance, was April 21, with physical delivery occurring between May 1 and May 31. Some market participants, however, may prefer more immediate delivery than a NYMEX WTI futures contract provides. Consequently, these market participants will instead turn to shorter-term spot price alternatives.
Taken together, these attributes help to explain the variety of prices used in the North American crude oil market. These markers price most of the crude oils commonly used by U.S. buyers and cover a wide geographic area.
Principal contributor: Jesse Barnett
A month ago, the world witnessed something never thought possible – negative oil prices. A perfect storm of events – the Covid-19 lockdowns, the resulting effect on demand, an ongoing oil supply glut, a worrying shortage of storage space and (crucially) the expiry of the NYMEX WTI benchmark contract for May, resulted in US crude oil prices falling as low as -US$37/b. Dragging other North American crude markers like Louisiana Light and Western Canadian Select along with it, the unique situation meant that crude sellers were paying buyers to take the crude off their hands before the May contract expired, or risk being stuck with crude and nowhere to store it. This was seen as an emblem of the dire circumstances the oil industry was in, and although prices did recover to a more normal US$10-15/b level after the benchmark contract switched over to June, there was immense worry that the situation would repeat itself.
Thankfully, it has not.
On May 19, trade in the NYMEX WTI contract for June delivery was retired and ticked over into a new benchmark for July delivery. Instead of a repeat of the meltdown, the WTI contract rose by US$1.53 to reach US$33.49/b, closing the gap with Brent that traded at US$35.75b. In the space of a month, US crude prices essentially swung up by US$70/b. What happened?
The first reason is that the market has learnt its lesson. The meltdown in April came because of an overleveraged market tempted by low crude oil prices in hope of selling those cargoes on later at a profit. That sort of strategic trading works fine in a normal situation, but against an abnormal situation of rapidly-shrinking storage space saw contract holders hold out until the last minute then frantically dumping their contracts to avoid having to take physical delivery. Bruised by this – and probably embarrassed as well – it seems the market has taken precautions to avoid a recurrence. Settling contracts early was one mechanism. Funds and institutions have also reduced their positions, diminishing the amount of contracts that need to be settled. The structural bottleneck that precipitated the crash was largely eliminated.
The second is that the US oil complex has adjusted itself quickly. Some 2 mmb/d of crude production has been (temporarily) idled, reducing supply. The gradual removal of lockdowns in some US states, despite medical advisories, has also recovered some demand. This week, crude draws in Cushing, Oklahoma rose for the second consecutive week, reaching a record figure of 5.6 million barrels. That increase in demand and the parallel easing of constrained storage space meant that last month’s panic was not repeated. The situation is also similar worldwide. With China now almost at full capacity again and lockdowns gradually removed in other parts of the world, the global crude marker Brent also rose to a 2-month high. The new OPEC+ supply deal seems to be working, especially with Saudi Arabia making an additional voluntary cut of 1 mmb/d. The oil world is now moving rapidly towards a new normal.
How long will this last? Assuming that the Covid-19 pandemic is contained by Q3 2020, then oil prices could conceivably return to their previous support level of US$50/b. That is a big assumption, however. The Covid-19 situation is still fragile, with major risks of additional waves. In China and South Korea, where the pandemic had largely been contained, recent detection of isolated new clusters prompted strict localised lockdowns. There is also worry that the US is jumping the gun in easing restrictions. In Russia and Brazil – countries where the advice to enforce strict lockdowns was ignored as early warning signs crept in – the number of cases and deaths is still rising rapidly. Brazil is a particular worry, as President Jair Bolosnaro is a Covid-19 skeptic and is still encouraging normal behaviour in spite of the accelerating health crisis there. On the flip side, crude output may not respond to the increase in demand as easily, as many clusters of Covid-19 outbreaks have been detected in key crude producing facilities worldwide. Despite this, some US shale producers have already restarted their rigs, spurred on by a need to service their high levels of debt. US pipeline giant Energy Transfer LP has already reported that many drillers in the Permian have resumed production, citing prices in the high-US$20/b level as sufficient to cover its costs.
The recovery is ongoing. But what is likely to happen is an erratic recovery, with intermittent bouts of mini-booms and mini-busts. Consultancy IHS Markit Energy Advisory envisions a choppy recovery with ‘stop-and-go rallies’ over 2020 – particularly in the winter flu season – heading towards a normalisation only in 2021. It predicts that the market will only recover to pre-Covid 19 levels in the second half of 2021, and a smooth path towards that only after a vaccine is developed and made available, which will be late 2020 at the earliest. The oil market has moved from certain doom to cautious optimism in the space of a month. But it will take far longer for the entire industry to regain its verve without any caveats.
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