Our Opinion: 2020

Oil Prices plunging over global GDP shock

After plunging into negative territory last week, oil prices surged 20% today (from a very low base). The plunge is due mostly to the technicalities of how oil is traded: using futures contracts. These are deals to buy and take delivery of oil, or sell it, at a certain point in the future. Futures cover various periods of time, from one month to several years. The price typically quoted is for the front-month, or current one, and this is where the collapse occurred.

The price of US oil benchmark West Texas Intermediate (WTI) plunged by more than 300% early last week, taking prices for delivery next month from $17.85 a barrel to an unprecedented minus $37.63 at the market close. European prices remained above zero, but Brent crude (the benchmark non-US futures) still tumbled 22% to a 21-year low around $15 a barrel.

The trigger for the fall in the price of the May WTI future was plunging demand. The International Energy Agency forecasts that global oil demand will fall by 29 million barrels per day (mbpd) this month, a decline of about one-third compared with last year’s levels. That has created a huge surplus, recently thought to have reached about 20mbpd.

With demand plummeting, the price of a contract to take delivery of oil in May duly plummeted too. Traders panicked. With the delivery date for May’s oil contract fast approaching, there were no buyers for their oil paper and no storage space available to put it in the meantime. That forced them to pay businesses that are equipped to handle the delivery of thousands of gallons of a volatile, toxic fuel to take the problem off their hands. The result was negative prices.

America has emerged as the world’s top petroleum producer in recent years, but the country’s storage and transportation infrastructure has struggled to keep up. European crude traders have opted to wait out the price slump at sea, paying $200,000 a day to charter crude tankers to store excess oil. Landlocked American oil producers have no such storage fallback. The result is that the country’s oil became less than worthless.

It doesn’t help that US producers have been slow to turn off the supply taps. More than 12 million barrels of oil still come onto the local market every day despite the existing glut.

This slump is more than a mere quirk. Oil hasn’t been this cheap since 1971. Negative oil prices are more evidence of the extraordinary deflationary shock that Covid-19 has dealt to the economy. As global demand for goods and services evaporates, oil may not be the last market to experience such a severe price slump.

Most of the immediate pain of negative oil prices was probably limited to a small number of speculative investors caught on the wrong side of the price swing. Yet evidence that the oil market is unravelling has knocked confidence hard. America’s oil patch is having a heart attack as more and more heavily indebted producers are forced to turn off the taps.

A return to negative prices cannot be ruled out. The June WTI price is in positive territory for now – but it could run into exactly the same storage problems next month. Plummeting Brent crude prices suggest fear that international prices could go the same way as American ones. A volatile few months are in store for oil.

The outlook for the second half of the year, however, is improving. Output cuts by key producers Opec and Russia removing almost 10mbpd from global supply will start in May, while the latest price crash could prompt even deeper cutbacks on the US shale patch. Any easing of lockdowns could also help demand tick back up. Prices look set to stabilise in the second half. A new bull market, however, remains a distant prospect.

30th April 2020