April Newsletter 2020: Oil Market Review

April Newsletter 2020: Oil Market Review

Brent prices hits a new low not seen since the 1990s on an oversupplied market in a demand destruction environment

As of this moment, I have been working from home for a whole month, or in the words of my mother: “MY dining table is now a four-screen monstrosity!” Working from home is the new reality for most of us now. One upside to all this is that I am essentially immune to being late for work as commute has been reduced from the usual 1 hour to about 30 seconds. That and my monthly expenditure on booze has reduced significantly. I mean…. it is all about perspective, right? Lots of things to unpack for this month so let’s get to it.

OPEC+ meeting early this month culminated in the largest voluntary cuts in the history of the cartel of 9.7mbpd. It was a 3-day marathon that started on Friday and finalized on Sunday. With oil demand expected to drop up to 20mbpd, the market needed a production cut of at least 15mbpd to 20mbpd to slow the rate of crude storage across the globe. Of course, there was scepticism on whether OPEC+ had the determination to follow through with such a large cut. It brought about its own fair share of speculation and market volatility on Friday as details of the meeting were gradually released. Initial talks suggest a 10mbpd ~12mbpd cut with a gradual recovery in production ranging to Apr21. It represents about 20% of the collective OPEC+ production at the time. Somehow, a 20mbpd cut number was floated late into the night and that rallied Brent crude price to a week high of $36.40/bbl or about 17% above previous day’s settle. Optimism lasted for a while before markets realized that 20mbpd would require a gargantuan and, to be honest, highly unrealistic determination from the group representing almost half their total production. While the final number settled down to a 9.7mbpd collective cut with it still represented a monumental effort amongst all the members.

The meeting eventually dragged into a 3-day marathon as Mexico refused cut production by their allocated 400kbpd and insisted on only a 100kbpd cut. The primary reason why Mexico is not worried about free-falling oil prices is that it’s National Oil Company had already hedged its oil exports at about $49/bbl early this year, which was about $1.4 billion in the money at the time of the meeting. This insurance that they have bought gave them leverage against the OPEC+ agreements as they had already locked in their crude oil revenues. As a matter of principle, the OPEC+ has repeatedly implied that all participating nations will have to comply and take on an equal share, or the deal falls apart. I guess they did not learn from the feud between Saudi and Russia the last time and they got caught in this collective…. Mexican stand-off. Yep, I wrote an entire paragraph just so I could use this joke. By Sunday, Saudi and Russia finally gave in to Mexico with the US picking up the 300kbpd slack from Mexico basis commercial shut-ins in the country. This made the Mexican energy minister an overnight national hero.

Despite agreeing to the largest production cut in history, what OPEC+ managed to remove from the market was still woefully inadequate to offset the drop in oil demand which was estimated to be at 20mbpd as more nations go on lockdown and industries shut down. Even with the involuntary cuts from the US of about 2~3mpbd via mostly distressed shale projects, we are still looking at a surplus of ~7mbpd of crude that needs to find a home. This is the equivalent of trying to save the sinking Titanic by having the crew pour water overboard using buckets. I mean….it helps but doesn’t really stop the ship from being flooded. The general expectation is that at the rate that storage is filling up around the world, we would run of space in the coming months, with some places, like Cushing, Oklahoma more constrained than others.

This leads us to the historic decline in WTI prices on the 20th April where the last trading day of May20 delivery contract trades down to a historic low of -$40/bbl. With the Cushing storage expected to reach tank tops within weeks, traders rushed to offload their May20 obligations as they run a risk of having nowhere to store the products when the delivery comes. However, no one expected prices to drop so spectacularly below $0. I remember sitting in front of the aforementioned four-screen monstrosity and repeatedly looping through “Huh? What? Wait? Huh?” at 3 am in the morning. No one expected any seller to go like: “Here’s my stuff and here’s some money for your troubles.” It was joked that if you had bought 4 million barrels of WTI at the lowest point, it comes with a free oil tanker.

It was akin to the opening of Pandora’s box in the commodity and risk markets. Most risk models used by firms and banks run on an assumption that prices would not go below zero. Even in university, my lecturers used to say that going short is inherently riskier than long. The maximum downside on your long positions was your entire equity position while the short losses are technically unlimited. Obviously, that did not age well. Banks and clearers are already taking steps to prevent another May20 fiasco by limiting trading of the prompt contract or outright telling customers that their systems cannot accept negative pricing. Brent, which is traded on the European side and does not have physical delivery is unlikely to run into a similar issue as WTI but it still took a dive below $20/bbl as WTI prices crashed.

Sentiments remained strong in that demand will recover in the coming months as shown through the 12 months carry for Jun20 to Jun21 to reaching up to $18/bbl at one point, implying that markets expected Brent prices to almost double over the next 12 months. Looking at all the positive news lately, that might not be impossible. China, being ground zero of the Coronavirus, is largely back to business as usual with cities opening up and industries restarting. Korea largely have the virus under control and plans to gradually reopen the country in May20. Similar plans are being carried out in Europe after months-long lockdown. The US is said to be at the peak of the curve and the reported cases are expected to be on the decline in the coming weeks. We are slowly recovering, albeit at different paces.

Low demand in Apr20 with the start of Circuit Breaker.

As Circuit Breaker came into force, there was a noticeable drop in over energy demand in Singapore. As industries and firms shut down, there was an average of more than 500MW, or about 8%, the drop of overall peak demand. Off-peak (late night to early morning) energy demand remained fairly resilient with only a 150MW, or about 3%, drop. Despite the lower demand, Apr20 saw its fair share of market volatility with multiple days of prices hitting above $200/MWh.

As I browse through my social media late into the night (from all the work I am doing), I have noticed that we, as a society, have been polarised. There is the “Oh no! No more bubble tea!” group against “I can make my own bubble tea”. Then there is the “daily 20-minute exercise” group against the “I shall hibernate through this” group. If there is one thing that we all bond on, it will be our appreciation for our healthcare workers who work tirelessly to keep us safe. The occasional message that you send to your friends and family working on the frontlines would go a long way. Yes, I have the best segues. (And yes, I am among the “I shall hibernate through this” group in case you’re wondering.)


Zheng Tianbai
Analyst, Oil & Power
Written on 30th April 2020


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