Oil price promises more May madness
After April’s unprecedented negative futures contract pricing, there is every chance of more volatility to come
The oil price captured the public imagination considerably more than usual in April when the expiring front-month WTI futures contract plunged to not far shy of $40/bl into negative territory. Social media commentators became instant crude market experts, while analysts with genuine expertise saw heightened demand for their services as talking heads.
May has the potential to be no less volatile, with a feasible prospect of another dip into minus numbers. So, eschewing the Twitter and Facebook pundits, Petroleum Economist sought instead the views of several respected commentators on what the month may bring.
To, start, though, a cautionary disclaimer. “Oil price prediction has been something of a mugs’ game over time—a 50/50 call negatively moderated by the perils of human behavioural psychology,” warns Colin Bryce, a founder of consultancy Energex Partners after almost 30 years’ trading experience at bank Morgan Stanley.
And prediction is not made easier by the recent—although brewing for years—violent disconnect of the US onshore oil market from international trade due to physical constraints. This, in Bryce’s view, is as serious as to raise questions around WTI’s claims to be an international oil benchmark, either physically or financially, and emphasises the primacy of Brent.
“We expect to see continued severe downward pressure on prices” Wittner, Ice
But, purely on the trading psychology of ‘market feel’, “the sense would be that—with the uninformed, weaker souls largely liquidated—the very worst of the panic is over”, Bryce hazards, allowing fundamentals to take over.
And market fundamentals’ message to landlocked producers is, in Bryce’s view, to curtail production, although achieving the required restraint within May to clear the storage backlog is unlikely. “Oil should therefore continue to price below cash costs in these areas to encourage that restraint,” says Bryce, “while, internationally, ‘lower for longer’ must be the strapline.”
Bryce’s cautious bearishness, at least for May, is shared by Mike Wittner, head of oil market research at the Ice exchange, trading venue of the pre-eminent Brent futures contract. “Opec+ production cuts, while still far outweighed by the staggering demand collapse, still represent a significant first step toward addressing the oversupply,” says Wittner.
“But the cuts do not take effect until May, meaning they will not have an impact on arrivals in major consuming regions until the second half of June or July. So we expect to see continued severe downward pressure on prices, alongside high volatility,” he says.
“Further bouts of negative prices cannot be ruled out,” he continues. “Crude must either to go into storage or to force outright production shut-ins.”
The most severe storage constraints are around Cushing in the US, while waterborne Brent grade crudes have far greater logistical flexibility than WTI production. Europe also benefits from greater proximity to Asia, where demand is expected to recover fastest. As a result, “the discount of WTI Cushing to Brent could continue to be unusually wide,” Wittner predicts.
The dynamic of different pressures on WTI and Brent is also on the mind of Alex Booth, head of market analysis at cargo tracking specialist Kpler. “With Cushing already effectively full, if not actually full—and we may get there in the next couple of weeks—we should expect to see significant downside pressure to the June WTI contract,” says Booth.
But Brent also faces challenges, particularly around the shape of the curve. Kpler sees oil-on-water building as well as storage getting full. Thus, front-to-back Brent spreads may need to widen “to incentivise ever more expensive floating storage”, says Booth.
Interestingly, the cargo tracker has already picked up a reduction in Opec+ load rates through the second half of April. But it thinks “the alliance will struggle to bring down exports quickly enough” to substantially slow the 3.6mn bl/d onshore storage and 4.7mn bl/d oil-on-water average growth rates it has observed in April.
As well as a potential delay in any impact from Opec+ cuts, the market should also keep a watchful eye on compliance, cautions David Fyfe, chief economist at price reporting agency Argus Media. “While Saudi Arabia and Russia will wish to be seen to meet their commitments, overall compliance may be patchy,” he predicts.
In contrast, “US production shut-ins will accelerate, leaving US crude exports by the end of May at or below 2mn bl/d,” says Fyfe. “However, despite supply reductions on voluntary economic or logistical grounds, global storage limits will still be tested—restraining some inland physical prices to sub-$10 levels and risking renewed forays into negative territory for expiring June futures contracts.”
The most severe storage constraints are around Cushing in the US
On the demand side, “after a decline of nearly 20mn bl/d year-on-year in April, a recovery will be led by Asia, but the rebound in Europe is likely to be deferred until June and beyond,” he forecasts. Longer-term, in Fyfe’s view, total global demand will take 2-3 years to regain pre-crisis levels.
The sheer weight of the oversupply is particularly concerning to Charles Daly, chairman of consultancy Channoil. Assuming a 25mn bl/d mismatch between supply and demand in April, that would add up to 750mn bl across the month a whole. “Where do we put it all? On ships, in tanks and then what?”, he asks.
If Opec+ commit to 10mn bl/d of cuts and US and other producers not subject to mandated reduction contribute another 5mn bl/d—even leaving aside the issue of low long these would take to physically filter through—and demand manages a 5mn bl/d recovery on easing lockdowns, there would still be a 5mn bl/d mismatch and further stock builds, says Daly. Even just on the negative sentiment of that prospect, “negative WTI could happen again,” he suggests.
But not every view is uniformly bearish. “As the classic nursery rhyme goes, ‘March winds and April showers bring forth May flowers.’ The oil market might play out is own version,” says Alan Gelder, vice-president, oil markets and refining, at consultancy Wood Mackenzie. Albeit, he admits, the April showers, in demand terms, were more of a biblical flood.
May’s prospects are, nonetheless, brighter. “The Opec+ group is about to undertake its biggest ever cut in supply, US tight oil supplies are falling sharply, and high cost wells are being shut in,” says Gelder. And the re-emergence of Chinese traffic jams is a physical reminder that demand is also on the road back.
“The pace of crude oversupply will slow to a trickle and stocks will start to be drawn as we enter Q3 2020,” he predicts. Sentiment will remain key until stocks are clearly being drawn, but, in Gelder’s view, prices will recover.
“The worst of the demand fall is over,” agrees Caroline Still, cross-energy analyst at consultancy Energy Aspects. And, on the demand side, “the counter fall has just got going”. In effect, the depths of April’s despair has only “accelerated the supply response”—Energy Aspects expects global Opec+ and non-Opec supply to fall by 13mn bl/d between April and June.
Beyond that, while demand continues to rise, any attempt to push production back up may lag, due to a twin impact of the intervening low prices and technical issues such as well damage caused by shut-ins. “Therefore, we have likely reached the bottom for the Brent flat price,” says Still. On the other hand, “WTI risks being tested lower again in May as retail investors offload their long positions for the prompt month,” she predicts.
Consultancy Rystad Energy is also exercised by the costs of shutting in and then restarting wells particularly for small to medium-sized producers. “Many will just not be able to bear the cost and will be pushed out of the market,” predicts the firm’s head of oil markets Bjornar Tonhaugen.
But Rystad also has concerns on the downside, not least as expects global storage to hit absolute tank-tops in the second half of May. The month will also “see possibly the largest tanker accumulation off the US coasts”, says Tonhaugen, while “road and jet fuel demand will not return to normal levels for a while”.
The end of the month could also be characterised by “huge swings depending on how pre-negotiations [ahead of June’s Opec+ meeting] go and on speculations about what the group will decide”, he warns. On the flipside, “Opec may feel pushed to agree something very quickly, unlike the March meeting where urgency was not the watchword.”