Brent hits a 20 year low on Saudi, Russia price war and Covid-19 demand destruction.
Crude experienced one of the worst routs in history, with prices falling over 60% since Jan20, to levels not seen since the beginning of this century. The oil complex got hit with a double whammy of OPEC+ negotiations breaking down and demand destruction caused by the Covid19 pandemic escalating on a global scale. Unfortunately, the oil market was not the only casualty. Almost all commodities across the board took a massive hit. The equities bull run hit a solid wall and tumbled over 25% from historical highs, essentially erasing all of 2019’s gains and then some. Bonds seemed less attractive as well as nations around the world cut interest rates in an attempt to lower borrowing costs to stimulate the economy. Even precious metals like gold and silver, one of the traditional safe havens, had a temporary rout. The word on the street was that investors had to liquidate their gold holdings to pay for margin calls. For times like this, the age old adage of “Cash is King” comes to mind.
There was much anticipation for the OPEC + meeting as the market expectation was that the cartel of oil producers would recommend a further joint output cut of 600kbpd to 1,000kbpd to partially offset demand destruction from the Covid19. At that point in time, China was on full lock-down while Italy and Spain were already reporting thousands of Covid19 cases. Hence, imagine the market’s surprise when Novak (Russia’s energy minister) walked out of the meeting as negotiations fell apart.
In light of the escalating number of Covid19 cases in Europe and Asia, the Saudis proposed a larger 1.5 million bpd cut in supply to balance the market while Russia suggested to remain at current levels of production. There was a distinct split in objectives here. The Saudi want to support prices, which is understandable as they require crude to be at least $50/bb to balance their current account and $80/bbl to balance the budget. Russia relented to the view that demand destruction and market pessimism will inevitably depress prices regardless of supply cuts and decided to use this opportunity to wage a price war against the US shale complex. The cartel has ceded over 2.1 million bpd of market share since late 2019 to US shale and the trend did not look like it was going to reverse.
As the negotiations continued, Saudi Arabia took a risky move by issuing what was essentially an ultimatum: OPEC counties agreed to a 1.5 mbpd cut provided that non-OPEC (lead by Russia) join in and contributes 0.5 mbpd of cuts. If non-OPEC does not join the cuts, OPEC would abandon its cuts altogether. A marathon of an OPEC+ meeting ensued but for Russia, ‘nyet’ was ‘nyet’. Despite it only being a marriage of convenience, the divorce was spectacular. This essentially signalled the end of OPEC + and the beginning of an all-out price war between Saudi and Russia. Crude prices tumbled more than 30% as Saudi and Russia vowed to boost output in a demand destruction environment for market share. Saudi would boost production to 12.3mbpd from the 9.7mbpd in only Feb20. To sweeten the deal, they also offered record discounts for their oil by selling their barrels at $8/bbl discount to Brent. Russia countered by threatening to increase its production by as much as 0.5 mbpd.
The Saudis had waged price wars to squeeze out US shale before only to pull back due to concerns on the state’s revenue. Each time, US shale bounced back harder with more efficient technology and greater market share as shale proves more resilient than what the Saudis expected. Since Dec19, the US has become the largest oil producer in the world with a peak production of close to 13 mbpd. However, Russia might actually have its wish granted and bring US shale to its knees this time. With most of the shale’s breakeven price ranging from $48 to $52/bbl, current oil prices would render almost all shale wells non-viable. With banks having to write off over $1 billion worth of loans to shale companies last year due to low prices, credit facilities will only get tighter from here. S&P says about a third of the bonds are under review for a downgrade. Firms are already tightening their belts by cutting payroll, slashing dividends to shareholders and restructuring existing debt facilities. However, efforts might be for naught should there be a prolonged slump in oil prices as the shale patch slowly drains down its cash reserves as well as the patience of their investors and creditors.
However, despite all the drama the divorce of OPEC+ provided, it has since faded in terms of relevance as the Covid-19 Pandemic takes centre stage. As the number of confirmed cases rise and an increasing number of nations close their borders, global demand for the transportation fuel of choice, crude, is falling off a cliff. Air traffic has almost ground to a halt globally, petrol stations are empty as people start working from home instead of commuting to work and in the more serious cases such as in Italy and Spain, even industrial consumption of diesel has fallen as factories and plants shuts down. Analysts are currently estimating a 20% drop to oil demand due to the virus, that is 20 mbpd of crude that needs to find a home.
As the market comes to terms with the implications of demand destruction. The oil market’s contango (where prices in the future are expected to be higher than current prices) steepened massively. The price for oil 6 months from now is priced at a $11 premium over current oil prices. This has led to a mad scramble for storage spaces as traders sweep up the cheap crude that is flooding the market right now to resell it in the future at a premium. Land storage options are rapidly filling up with some traders already paying for storing oil in pipelines. VLCCs (very large crude carriers) rates have more than doubled since the oil plunge. The current estimate is that storage is being filled at about 600 million barrels per month. It is estimated that we have about 1.8 billion barrels storage capacity left in the market, which implies that we would be running out of space in about 3 to 4 months, provided that current situation does not improve.
One could also view the steep contango as market seeing optimism in the future and believes that prices would quickly recover once the world gets the virus contained. The price premium of crude in 6 months against right now has increased massively from $0/bbl to almost $11/bbl in a span of less than 1 month. This is a remarkable show of confidence in price recovery in the near term and strong government policies reflect that as well. China already has Covid-19 largely under control after only 3 months of lock-down with many provinces are already reporting zero infections for days. Even the epicentre of the virus, Wuhan, has been partially reopened. China has started to gradually recover with imported cases out-numbering local reported cases. This is a positive sign and shows that while the virus is highly infectious, it is not beyond our abilities to contain it.
Looking at the Chinese timeline, we could potentially see this whole thing blow over within the next 2 to 3 months. Especially as many countries are already implementing stringent measures to contain the spread. Nations across the globe are on lockdown with travel restrictions against inbound and outbound flights. The rate of increase in new cases in Italy, with one of the highest number of cases, is beginning to slow down as with most of Europe. Now all eyes are on the US and the Trump administration to see if they can contain Covid-19. With more than 160k confirmed cases, they are now at the centre of the pandemic. A record $2 trillion bill was approved to shore up the economy and provide for much needed medical supplies. Cities are currently on lockdown with employees being told to work from home. Hopefully, we would see the effects of the measure kicking in in the coming weeks.
There was a little spot volatility in Mar20 and relatively healthy demand.
Mar20 has been a relatively calm month with only some spot volatility at the start of the month due to reduced generation supply from scheduled outages. Demand has held up surprisingly well despite the impact of Covid-19 on work schedules with average peak demand at approximately the same level as Feb20. Hopefully, Singapore will continue to keep the virus under control but as we implement further social distancing measures to do so, we might see a dip in overall demand in the coming months as Covid-19 changes consumer consumption patterns.
To those that read this monthly report (however few there might be), I have a confession to make. As you might imagine, I pride myself on finding humour in bleak news in a (sometimes vain) attempt to make it interesting. However, for the past 1 month, it has been an increasingly difficult task. As Covid-19 continues to spread to communities around the world, I have noticed a recurring theme. Governments can only do so much. Many policies are only as effective as the extend of seriousness we, the people, take them to be. Here in the office, we are already adopting Team A, Team B rotations with daily temperature screening. This is to ensure that we can continue to function and provide services to our customers should the worst happen.
So, I would implore that everyone observes social distancing protocols and take as much precaution as they can. From covering your nose and mouth when coughing or sneezing, avoiding contact with people who are unwell, staying at home if you are unwell and washing your hands regularly with either soap or alcohol-based hand rub. I am doing one better by regularly ingesting alcohol as well, in the privacy of my own home or work desk (don’t tell my boss) and not a pub of course. Together, we can stop the spread of Covid-19.
Analyst, Oil & Power
Written on 30th March 2020
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