1 April 2020 – The $30/bbl level has been completely steamrolled, with both Brent and WTI having gone close to $20/bbl. Beyond the usual demand/supply dynamics, we now estimate that global storage for crude oil may run out within the next three months.
Continued production beyond those levels would probably drive prices lower and encourage negative carry on prompt deliveries – we would not put past oil falling to $10/bbl by that stage.
The oil market is facing Armageddon. The twin combination of demand destruction and oversupply proved too much for crude oil to handle and the numbers have been pretty grim.
Crude oil prices – both Brent and WTI – are less than half of what they were at the start of March. Gasoline futures, at its lowest in March, were one-fifth the value from when it started 2020.
Jet fuel for prompt delivery in the US Gulf Coast is trading at levels not seen since 2003. The bad news? It might get even worse.
With a V-shape economic recovery out of sight, expect effects of demand destruction to continue long into the future. The Russia-Saudi Arabia fallout may have precipitated the 9 March collapse in prices, but
the real driver of bearishness right now is demand.
Recall that when the coronavirus was largely confined to China, most expected a sharp V-shape recovery in 2H 2020. That is no longer the case.
The COVID-19 episode has spread too far and has lasted too long that it is now expected to have irreparable damage to incomes, consumption spending and investment plans globally. The anticipated recovery is now, at best, a heavily flattened V, if not a protracted U.
We are now too deep down the rabbit hole to be rescued by any potential output cuts. Multiple private estimates in the market expect oil demand in April to sink about 20% yoy, which roughly approximates to about 20mbpd.
Even if Russia and Saudi Arabia unexpectedly returns to its former alliance, the output cuts would hardly exceed more than 4mbpd (2.5mbpd from the previous arrangement plus the proposed 1.5mbpd additional cuts). That may temporarily support the market, but is hardly enough to send oil back to its pre-crash levels.
The psychological upheaval to the market cannot be underestimated. If OPEC+ had never disintegrated in this manner, there might have been a possibility that prices would currently be trading higher now, even though the market is facing the same magnitude of supply imbalance.
With WTI now close to $20/bbl, there exists multiple levels of psychological hurdles for the benchmark to even return to the sub-$40 levels. In fact, a return to the $40 level would mean a doubling of prices from current levels – a sobering thought.
The most pressing problem right now is the potential peaking of global crude storage. While an elusive figure, multiple agencies have forecast remaining global crude oil storage at 0.9 – 1.8 billion barrels.
The global supply surplus in April would possibly be at least 20mbpd – this is solely from the demand drop in point (2), and has yet to include the current supply surplus (about 1.5mbpd by our estimates) and the expected increase in supply (about 2mbpd, by our estimates).
Conservatively, we estimate global crude storage to thus peak within the next 60-90 days, although we note that other private estimates are calling for as short as 30 days.
What happens when global crude storage reaches maximum capacity? Two scenarios might unfold here.
First, many production plants might grind to a complete stop, as seen in the case of Libya recently. However, some of the national oil companies (notably Saudi Aramco) may continue producing due to their very low costs.
In the latter instance, the spot market may flip into negative carry. In simpler terms, producers and refiners start to pay downstream buyers to take physical cargo off their hands, in the hope of passing the buck of storage down the line.
While counter-intuitive, to most producers the costs of negative carry is probably still cheaper than halting production altogether. But as one might suspect, this strategy has a limited shelf-life before the inevitable shut-in happens.
Do not expect respite from floating storage. Freight rates have increased as Saudi Arabia has already started booking VLCCs (very large crude carriers) to transport its increase in output from April onwards.
Rystad Energy estimates only 57 VLCCs left globally that may be used for storage, with one vessel’s capacity at 2 million barrels. An additional 114 million barrels of storage would just buy the market one extra week of storage.
Don’t count on the SPR either. The US SPR has an additional capacity of 77 million barrels. That buys the market another three days of storage.
At any rate, the SPR purchases have been temporarily shelved after funding for this plan was not present in the $2 trillion package by the US Congress. It may return in a separate bill, but it is anyone’s guess when that may occur – especially with politicians busy preserving jobs and ensuring sufficient liquidity in the economy.
$10 oil? Don’t bet against it. These are unprecedented times that may yield extraordinary outcomes.
A lockdown in cities worldwide would have been unthinkable at the start of 2020, yet both China and the US have done so in Q1. No one ever thought oil could drop 24% in a day, but yet it did last month.
Our forecast of $30/bbl oil – which at that time, we thought was aggressively bearish – has been completely steamrolled. The worst is probably yet to come.
When global storage approaches maximum capacity, another wave of selling might happen. By that stage, even $10 oil would start to look expensive.
Read more: IMF: We have entered recession