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Monday, April 06, 2020

Oil Wars - Making Sense of Current Chaos & The Way Ahead

تم إعداد هذا المنشور من قبل سنشري للاستشارات

Oil Wars - Making Sense of Current Chaos &...
Oil Wars

Oil prices at one point of time had tumbled by more than 70%. The situation has become so dire that some US & Canadian benchmarks are trading dangerously close to $ 0/barrel. Canadian Western Select, benchmark for Canadian oil sand industry dipped to $ 4 levels while Midland Texas crude is about to break below $ 10 levels. Oklahama Sour is trading near $ 5 levels whereas Wyoming Sweet prices are down to $ 3 levels. This has caused some products being sold at negative prices. Energy trading giant Mercuria recently bid -19 cents/barrel for Wyoming Asphalt Sour in effect asking producers to pay for getting rid of their output. Economic prospects for major global oil refiners & producers around the world have become so bad that some of them are considering or have already closed their refinery output.

In India, top refiners Indian Oil Corp and Mangalore Refinery and Petrochemicals have declared force majeure, with MRPL in the process of shutting down its entire plant. Italy's API said it would close operations temporarily at its Ancona refinery. Spain's Repsol would cut runs by about 10 % at its complex refineries. Several US refineries have also decided to cut their output with plants in Texas announcing the same. This comes even as US total oil production currently stands near 13 mbpd, near previous record high.

Global Petroleum and Other Liquids Global Petroleum and Other Liquids

Oil Market Chaos – Making Sense

Oil prices are currently suffering from double whammy of increased oil supply as well as lower oil demand. On the demand side, ongoing spread of COVID -19 pandemic is expected to reduce 2020 oil demand by at least 25 % to 30 %. On the supply side, ongoing oil wars between Saudi’s & Russian’s has caused major supply glut across the entire global oil market supply chain. Small producers too have jumped into the fray to increase their market share.

Post the outcome of March 6 OPEC meeting, EIA’s forecast now assumes that OPEC will target market share instead of a balanced global oil market. EIA forecasts OPEC crude oil production will average 29.2 million barrels per day (b/d) from April through December 2020, up from an average of 28.7 million b/d in the first quarter of 2020. For Brent price forecast, EIA now forecasts crude benchmark prices will average $43/b in 2020, down from $64/b in 2019. A ray of hope lies in EIA’s 2021 forecast where it sees Brent prices touching $55/barrel on back of declining global oil inventories.

For Saudi’s, this time it is a battle of egos with kingdom clearly wanting to show to the world their dominance. Saudi Arabia’s aggressive stance is on back of Russia’s reluctance to agree to OPEC’s decision to reduce oil output in light of falling oil demand. Since past many years, Saudi’s even went further by cutting additional oil production to cover up surplus from other OPEC+ members. Russia on other hand is focused on playing its own geopolitical game to see US Shale oil producers getting out of business with lower oil prices. Drilling costs associated with shale oil extraction is considered to be relatively expensive as compared to normal onshore/offshore drilling. This is due to expensive hydraulic fracturing or fracking technology. As per market estimates, average production cost for shale drilling is range of $ 40 - $ 90/barrel. Compare this with onshore/offshore drilling cost of $ 44 - $46/barrel for Russia & the math is clear. For Saudi Arabia, the production cost happens to be lowest in the world within range of $ 10 - $ 15.

Looking at the below chart, WTI prices have touched a 19 year low whereas Brent prices have touched 18 year low. Such lower prices have created a super contango structure where in the long dated Brent futures contract beyond 6 month expiry are trading at a premium of $ 10 + as compared to current spot prices. For Brent, the contango premiums are near 10 year high indicative of massive supply glut prevalent in the market. Major oil traders are making use of this and have booked massive amounts of onshore as well offshore storage capacities. Freight industry & big shipping players are having a roll with prices of oil tankers more than doubling since start of this year. Saudi Arabia’s oil tanker spree has reportedly seen around 700 % rise in ship earners income. This comes as the kingdom has hired dozens of large oil carries in order to store their oil surplus.

WTI prices WTI prices

Path to Recovery – Way Ahead

President Trump is reportedly putting immense pressure on both Saudis & Russians to come back to negotiating table & work around on some sort of compromise. Whether or not both sides agree, path to recovery for oil prices is going to be a complex one. The world is staring at massive supply glut with leading industry consultant IHS Markit putting surplus in the range of 800 million to 1.3 billion barrels for H1 2020. On a monthly basis, the excess could range from 4 - 10 mbpd from February to May, with demand in March and April down by as much as 10 mbpd. US oil industry is likely to bear the brunt with their output expected to drop in range of 2 – 4 mbpd over course of next 18 months.

Looking at the past recoveries for WTI & Brent, the benchmarks have taken at least 6 months to 1 year for gaining back 80 % to 100 % of their original price levels. During last GFC of 2008 when Brent prices fell to low of 36, prices recovered to their high of $ 128 only during start of 2012. Similarly for WTI, prices recovered from low of $ 35 to high of $ 114 only during mid of 2011. As such the journey for oil price recovery would most probably be a long one with traders increasingly using the ongoing recessionary theme to sell on any rallies. Oil prices are likely to consolidate further at these lower levels with any short term bounce likely to be sold. Global economy is poised to enter into an extended period of slowdown & even recession should the current lockdown measures extend beyond April end. Long term investors are best suited to make use of these lower oil prices to start accumulating & even average out their buying prices on any dips. In case of further upswings, this may provide them with good value & further new opportunities.

Data Source: Bloomberg

Arun Leslie John
Chief Market Analyst

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