Until the lockdowns are lifted in most countries, and airplanes begin to fly and economic engines start to hum, even if not to full capacity, and demand reaches over 90% of the pre-pandemic levels, oil prices will be controlled by coronavirus, and not by OPEC+ or President Trump!
By Nazarul Islam
As the third week of April progressed, those who had reasons to look at the existing oil prices at their computer monitors, stood baffled. They simply could not trust their eyes. Oil futures for the coming month of May 2020, for the benchmark West Texas Intermediate (WTI) had started to reveal negative prices. After reaching minus (-) $40 per barrel, oil prices finally ended at -37.63/barrel—a historic drop of $58/barrel in one, single day.
The debilitating impact of the corona virus pandemic has caused many surprises and historic firsts—the maximum daily drop in oil prices, unprecedented demand drop and the production cuts, along with historic support tendered by the nations of G-20 to OPEC+ countries. This event which will be written in the history books —as that of the ‘black gold’, being sold at negative price.
How did this monster manage to turn its head around? The simple explanation is that the May 2020 oil contracts would have expired within a day and those who had held contracts had to take physical delivery of oil.
Under normal circumstances, this is not a problem at all. However, at this particular juncture, there was no oil storage space available. International benchmark Brent futures not only did not fall in negative territory, but showed only a small decline of $2.5/barrel. In the case of Brent futures, cash payment is also allowed.
In order to understand and appreciate how we wound up, getting into the negative prices, we need to learn more about the latest oil drama. Obviously, this was stage-managed by the world’s “greatest” deal maker, US President Donald Trump, with the help of Russian President Vladimir Putin and Saudi Arabia’s crown prince, Mohammed bin Sultan.
When Russia walked out of the earlier OPEC+ meeting on March 6, of this year oil price had dropped to the lowest level since August 2016 and it set the stage for this oil drama, which took place from April 9 to 12 of the current year. Trump, Putin and MBS had thought that they could control the global oil prices. In reality, it was the little invisible contagion, the coronavirus, which emerged as the invisible, game changer.
Finally, the OPEC+ (OPEC plus 10 more oil-exporting countries, led by Russia) agreed to reduce crude oil production on April 9. The next day, G-20 members had supported the agreement by agreeing to cut some more production.
Soon after the agreement, Trump had trumpeted that the negotiated reduction was 20 million barrels per day (mmbd) and not 15 mmbd as was earlier reported in the media. However, only after realistic estimate is made, the true reduction turned out be around 10 to 11 mmbd.
And, purely for reasons of the lockdown in most countries, oil consumption had already collapsed. One need not be a ‘genius’ to figure out that oil inventories had reach historical highs by the end of April, sufficiently to put pressure on storage facilities—that keeps getting rapidly occupied.
According to IEA, the oil demand is likely to drop by 29 mmbd in April and for the whole year, it may drop further by 9 mmbd. It is likely that the demand may recover only by a small amount in May and not much in June. Some experts estimate the demand drop in April could perhaps be exceed more than 35 mmbd.
Never in global oil history has the demand fallen so much so rapidly. Unless the global economy managed to pick up within a few months, the drop in oil demand may be even larger. Therefore, the production cut, stage-managed by the three global leaders/actors, would not be enough to balance demand and supply.
It is indeed a mystery why OPEC+ had to wait for May 1. 2020 to implement their production cuts. By early April, there were clear signs that there will be a scramble for storage. Shippers were getting attractive offers and so also those who owned storage space facilities.
Despite such a dramatic development, Saudis and Russians were competing against one another to increase their market share before the production cuts could kick in. While oil companies —large and small—in the US and in other countries, were forced to cut production by market forces, the cuts were just not enough to balance the existing supply and demand.
However, if the coronavirus pandemic and death rates would have started to decline quickly, there could have been a quick V-shaped economic recovery. In such a scenario, oil prices may have recovered to climb over $60/b by the end of the year. But in terms of the present situation, it does not look likely to happen.
The future market, although not very reliable, is reflecting that oil prices will climb to around $30/b by year-end. Such an increase will not support shale oil production in the US. That in turn will not help Trump’s re-election campaign.
For most shale producers, the break-even cost is around $40/b or higher. As a result 2.0 -2.5 mmbd of shale oil production is likely to be shut down till the market fully recovers and oil price rises above the break-even cost. There will also be market-driven production cuts in other countries which will result in a fairly balanced or tight market if and when the demand picks up later in the year.
But in today’s market, experiencing a ‘black swan’ event due to which demand for oil has dropped 25-35%, neither the OPEC+ nor the non-OPEC members of G-20 can do much to support a higher price. The old strategy of the cartel allocating production quotas will not work.
The historic negative price is another proof of market power when demand is controlled by the little invisible creature and not by any economic factors. Finally, it is the market that will decide who will produce oil, depending on who can produce it at below break-even cost. Based on IEA analysis, such a break even cost is around $15 per barrel.
In short, until the lockdowns are lifted in most countries, and airplanes begin to fly and economic engines start to hum, even if not to full capacity, and demand reaches over 90% of the pre-pandemic levels, oil prices will be controlled by coronavirus, and not by OPEC+ or President Trump!
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