Investing.com’s Commodities Week Ahead typically looks at the prospects for oil and gold prices in the upcoming trading week. In this two-part series, however, which began on Sunday, we examined the Trump administration's attempts to save the U.S. oil industry amid the collapse in demand for crude from the coronavirus crisis and the production-and-price war between market titans Saudi Arabia and Russia. Read part 1 here.
We continue with that theme in this final installment, and also explore the economic and longer-term conditions required for the market’s comeback:
If you thought oil would go to $40 this week because Donald Trump could make the Saudis and Russians cut millions of barrels of production simply by asking or threatening them in order to save U.S. shale crude, please push the reset button in your head.
Going from a “not thinking about it” stance on Friday, to a “will do whatever I have to do” mode by Saturday, before shifting tack again to a "if the oil price stays the way it is” posture by Sunday, the U.S. president was as ambivalent as he could be on his threat to tax Saudi and Russian crude to protect domestic drillers.
After U.S. West Texas Intermediate gained a record 32% last week and U.K. Brent 37% on Trump’s tweets that Riyadh and Moscow could remove 15 million barrels per day from a globally oversupplied pool because of his calls to their leaders, both fell in Asian trading Monday as it became clear the market was chasing a red herring.
Instead of maintaining their initial plunge, the two crude benchmarks came off their lows by late afternoon in Singapore, after tracking a run-up in futures of Wall Street’s Dow Index ahead of its New York open — again on Trump’s remarks that the coronavirus threat was “leveling-off” in some U.S. hot spots. The country’s top pandemics expert Anthony Fauci, meanwhile, said it was still early to make that call.
Trump warned Americans last week to brace for a “very painful” two weeks ahead from the coronavirus. My prognosis is U.S. oil producers need to brace for a very painful 20 weeks at least and a longer period of $20-plus oil as the economy could likely take 20 months or maybe more to return to pre-crisis levels, after the epic job losses, imminent recession, and possible depression, to come.
“It’s The Economy”
Bill Clinton’s 1992 campaign for the White House said it most aptly: “It’s the economy, stupid!”
More than any other asset, commodities are the true reflection of an economy as they are the staples of everyday life. And oil is the commodity that literally moves the world. Now, with more than 90% of the world economy on standstill as authorities try to restrict contact and movement among people to prevent the spread of the coronavirus crisis, oil as a market is virtually dead. It’s simply going to get a lot worse before it can get somewhat better.
“The U.S. economy hasn't stopped but it’s kind of like driving a car into a brick wall at 90 miles an hour, and for it to start back up again, somebody has got to put the car back together, and you then want to get in the car and actually drive it,” said Tariq Zahir, founder of the New York-based oil-focused Tyche Capital Advisors. “It's that bad.”
For a sense of how bad it is, the global aviation industry is practically grounded, except for medical and emergency flights. Consultancy Rystad Energy expects demand for jet fuel to be hit the hardest, with at least a 21% demand drop this year, from 2019.
In most parts of the world, no one is driving without reason too. U.S. gasoline stockpiles surged by 7.5 million barrels for the week ended March 27, versus forecasts for a rise of about 1.95 million barrels. A bigger build is expected for the latest week to April 3. Moody’s estimates that global car sales could fall by 2.5% — a conservative call by any count. Global road fuel demand will fall by 5.5%, or 2.6 million bpd year-on-year, Rystad estimated.
Cruise liners face an even worse carnage, with most looking like they could collapse without a government bailout.
Whole U.S. cities that never slept, like New York and Vegas, are now barely awake. Year-round tourism draws like Disneyland (NYSE:DIS), as well as seasonal theme parks are all shuttered. Not only are retail icons like Macy's (NYSE:M), Apple (NASDAQ:AAPL) and Best Buy (NYSE:BBY) closed, even the little guys, like the corner pizza outlet, clothing square and auto repair garage, may go out of business soon.
Big or small, every one of these contributed to the massive trucking demand that fed much of the fuel consumption that made up oil’s demand component.
Yes, you still have a ramp-up in trucking and transportation related activity as e-commerce and courier companies from Amazon (NASDAQ:AMZN) to United Parcel Service (NYSE:UPS) and FedEx (NYSE:FDX) race round the clock to fulfill orders that have stretched their delivery capacity to the max.
U.S. distillates inventories unexpectedly fell by 2.2 million barrels for the week to March 27, compared with expectations for a build of about 1.03 million barrels. Distillate fuel production also rose by 5 million barrels. In the most simplistic interpretation, that underscored the jump in trucking fuel demand.
Yet, that number wasn’t a true reflection of the loss in accounted trucking demand, like the haulage of new cars from factories to dealerships.
Oil Funds in Distress Too
Zahir said he expected a good number of hedge funds in the energy space to close as well from a lack of funds, saying he practically had no chance of raising money anymore for his Tyche Capital.
Yet, he was still surviving as a proprietary trader. With the daily dose of accurate information and misinformation on the virus, oil and the economy, there’s plenty of volatility to trade the market, and maintain a short, bearish, bias in most cases.
The CBOE Crude Oil Volatility Index spiked double-digits three times since March 6, most recently after Trump’s Saudi-Russian tweets on Friday.
“The best would be to play spreads with the contango, as we still have one of the most massive contango ever,” said Tariq Zahir, founder of the New York-based oil-focused Tyche Capital Advisors, referring to the discount in the spot futures contract and oil for nearby or farther dated delivery.
During Monday’s Asian hours, spot Brent for June was cheaper by $1.50 a barrel versus the July Brent — a difference highlighting the oil storage dynamic now in crude, as almost every trader tried to buy oil that could potentially be held over for a better price in the future than current rock-bottom prices.
On Friday, when Trump’s tweets landed, Zahir said he was shorting long-dated Brent spreads at $21 per barrel. The front-month contract itself jumped $4.71 on the day.
“I got to a standpoint where I said, ‘Let me get out’. Because a lot of people will get in because it’s a big short covering rally. But I’m back to shorting again today.”
More Granular Picture For Crude
In a more detailed picture for crude, major oil producers are preparing an unprecedented wave of shut-ins to pull production from the market as quickly as possible, Energy Intelligence, another consultancy, said.
“It’s not clear what the ultimate impact of widespread shut-ins will be on the industry.
Wells will be brought back on line but there is real worry that certain reservoirs may suffer reservoir damage.”
Over the longer term, oil supplies will fall, as the Saudis and Russians logically have to turn their taps down as global storage capacity for crude and products is poised to run out fast and soon. Unprecedented demand destruction from the coronavirus combined with Saudi Arabia’s market flooding point to overflowing tanks in the coming weeks, which will bring more price pain.
So, Trump may get his wish on getting the Saudis and Russians to lower their output. But it might come a little late for U.S. shale drillers, who may have to throw in the towel first, consistent with estimates showing that some 30% of them will still go bust this year.
If oil can’t be sold or stored, it can’t be produced at much higher rates, and there have to be rampant shut-ins by high-cost producers like U.S. shale drillers, who typically turn out a barrel at $35 and above. The Saudis, whose costs are as low as $3 per barrel, are likely to hold off as long as possible. International Energy Agency Executive Director Fatih Birol tells Energy Intelligence that the current supply glut threatens to overwhelm effective global storage capacity in just 10-15 days.
Demand is broadly expected to hit a low point during the current April-June quarter and Birol expects the demand decline for the quarter to be around 20 million bpd — around 20% of total global demand. Coronavirus containment measures have slashed demand for transportation fuels, prompting a huge refined product surplus in the first quarter. But as product storage tanks near their top, the problem rapidly extends to crude this quarter. Around 20 million bpd of crude will move into storage in April, according to Goldman Sachs.
Rystad Energy estimates upstream capex plans have been cut by roughly $100 billion this year and will hit a 13-year low of $450 billion — roughly half the peak spend in 2014.
The industry significantly reduced its break-evens following the 2014 price collapse, but kept many of those efficiency levers engaged to court increasingly skeptical investors with improved financial performance and bigger returns amid $50-$60 oil.
After the latest savage capex cuts, there simply aren’t many moves left to make: reeling services companies can’t be squeezed any further and producers are already running lean operations that prioritize the lowest-cost projects. Big Oil is set to shrink, and material production declines will put long-term strategic priorities at risk.
Therein will come oil’s self-induced production controls over time.
But those controls won’t bring back pre-crisis level demand. For that demand to return, consumers must again feel safe to return to life as it was before — which is only likely to happen when a working vaccine and drug is available for COVID-19, a process that could take up to 18 months.
Editor's Note: Read part 1 of this series here.