A day for the history books and one shale producers will want to forget
On Monday night the WTI contract for May ended in negative territory closing the day at minus $37 per barrel. This is a serious market dislocation. It reflects that the US is running out of storage space. (The May contract expires at 2 PM EDST tomorrow.) On Tuesday mid morning WTI traded at $1.40
This was unprecedented and Monday was indeed a day for the history books.
The discrepancy between WTI and Brent, which traded at $ 20.70 mid-morning, can be explained by the fact that WTI is landlocked and priced at Cushing, in Oklahoma where storage is either full or spoken for. In other words, WTI crude had nowhere to go and off-takers need to be compensated to take delivery. Brent is globally traded and seaborne. It has therefore more opportunities to find starage, which is however also running out fast. The negative price reflects a massive dislocation of the financial markets which have a much higher volume than the physical market.
Mid-morning in Europe the June contract traded at $11.79. Where it will trade mid-May, which is the rollover period for the June contract, will depend on both the storage situation at Cushing and the supply-demand picture then — which in turn depends on how major economies emerge from their respective lockdowns.
The share price of big oil companies (BP, Shell, etc.) tumbled as well, but in the single digits only, which is a reflection that they have the wherewithal and balance sheets to ride out the storms.
US President Donald Trump’s administration has announced filling up the strategic reserves and is also bound to fast-track a program to pay companies to leave crude in the ground.
Recent developments will crush many smaller producers in the US, which will have huge ramifications for the banking industry and employment in the wider sector, including oilfield services. Most smaller shale oil producers are highly leveraged and can no longer meet their loan obligations, resulting in a string of bankruptcies and a deterioration of their loan portfolios.
Banks holding hedges at higher oil prices will be caught out. The sector lost 51,000 jobs since the outbreak of the pandemic.
Owners of rail wagons, tankers and storage facilities can name their price at this point.
The deterioration of WTI is about storage and a landlocked benchmark. But whichever way the oil price is looked at, it is in real terms at its lowest level since 1971.
It is also about an unprecedented demand destruction for oil. The situation will only relax once demand picks up again when major economies come out of lockdown. A lot will depend on how the recovery looks and how quickly air travel and driving resumes.
What the coronavirus disease (COVID-19) pandemic will do to supply chains will have a huge impact on air and sea freight, which would be negatively impacted by a regionalization of supply chains.
For oil-producing countries the situation is serious as imploding demand hits their budgets hard, impeding their spending plans.
It is interesting to note that for the first time GCC national oil companies (NOCs) are looking at slashing some of their capital expenditure (capex). While oil majors are well known for canceling planned capex in times of low oil prices, the GCC NOCs have so far always adhered to their capex plans come what may. This is an indication of just how dire the situation has become.
On a positive note, the International Energy Agency (IEA) forecasted in its monthly oil market report, which was published last week, a demand overhang for the second half of 2020, which will ease the pressure and eventually lead to a drawing down of stocks. This will however depend on the space and speed of any recovery. The remaining question is what shape the global oil industry will find itself in when the world comes out of the COVID-19 crisis? The low-cost producers of the GCC will certainly have an edge, but they will not escape unscathed either. The US oil industry will certainly be affected, especially shale.