Marius Paun | London, UK | Senior dealer | Tuesday, 31st March 2020
The oil futures prices have collapsed recently and, during the early Monday session, reached an 18 year low of $19.27 per barrel. Oil is being hit by a double whammy, an excess of supply and a massive cut in demand largely due to an unfortunate combination of coronavirus and price wars.
On the crude supply side, Saudi Arabia and Russia started their oil price dispute just around the time when the coronavirus outbreak turned into a global pandemic. There has been speculation that despite the bad blood in the mainstream media, the two sides have a secret understanding and are trying to push oil prices down, to put the US shale oil industry out of business. The reason for this is that the US shale producers, although they amassed huge levels of debt, did manage to place the US as the top oil producer in the world, currently ahead of Saudi Arabia.
The Russians and the Saudis are also hoping they can withstand these new low prices better than the Americans, each in its own way. Although the Russians have a high producing cost because their oil reserves are mainly in weather challenging regions, it is estimated they are capable of enduring a rather long period of low prices. Saudi Arabia has very low costs, some say even single digits, but in order to fund their significant public spending, they need high prices to balance their budget. Will they cut the spending temporarily?
Conspiracy theory or not, the oil supply is rising to levels never seen before. Oil traders are saying that at Cushing, Oklahoma, the main US crude storage hub, inventories soared by more than 4 million barrels last week alone.
If the US shale oil producers do eventually go bankrupt, their correspondent debt, which is rumored to be quite consistent, will, in turn, become worthless. According to the Financial Times the volume of US drilling rigs, as reported in the Baker Hughes numbers, recently saw the biggest fall in five years. The snowball effect of these closures could create a crisis in the corporate bonds market and that’s the last thing the US officials need right now.
Pressed by the powerful Texas oil industry, the US President Donald Trump spoke with Russian President Vladimir Putin on Monday to discuss an attempt to get energy markets more stable. That had barely no direct effect in oil prices although, at the time of writing on Tuesday, a more meaningful rally back was trying to get underway.
Testimony to the level of oversupply is the fact that the front-month US oil future contract, WTI May is trading at around $12 per barrel discount to WTI November contract, the widest contango spread ever recorded. That means oil traders expect oil prices to be much higher in the future and encourages the practice of storing crude now and sell it later when prices recover.
On the other side, oil demand contraction is currently also a massive problem for producers. The coronavirus outbreak means everyone has effectively stopped flying. Airline company EasyJet has just announced that its entire fleet has been grounded and the crew has been made temporarily(?) redundant.
The lockdown measures were taken around the world, and possibly coming to the US pretty soon, means that people have also stopped driving too. Analysts are now predicting that gasoline demand could halve in certain areas. Expectations for a fall in oil demand for the coming weeks are now between 30% and 50% of the consumption at the end of 2019.
Another issue is that the world is running out of oil storage for the production surplus. It’s estimated that with the current trend we could see 100% storage capacity being reached within a few months. Some dire estimates go as far as saying it could happen in a few weeks.
It’s easy to see that some are floating the crazy idea of ‘negative oil prices’ where the producers actually will pay so that buyers take delivery. It speaks volumes of the levels of oversupply. And if you think that sounds too far-fetched, Bloomberg reported 4 days ago that ’one corner of the US oil market has already seen negative oil prices’. Somewhere in Wyoming producers are effectively now paying consumers to take away oil, to take it off their hands.
Under normal circumstances, a sharp fall in crude prices very likely would attract increased demand as people buy bigger, more powerful cars for example (the 1950s and 1960s in the US). Not so this time, as quarantine measures restrict demand. A ramp-up in oil production by Saudi Arabia and Russia, keen to put US shale out of business also offers little chance for a supply reduction in the near future.
The bears are fully in control as indicated by the long-term chart. The price is well below moving averages and both the short-term and long-term ones are pointing down. It also shows a lower highs and lower lows since oil touched its peak of $147.27 on the 1st of July 2008.
We’re now looking at the lows of 1st of February 2002 at $19.09 for the next support. If that level does not hold the sellers would grow increasingly confident to push for $17.12 the low of 1st November 2001. Notably from a technical viewpoint, we can see again three consecutive downwards candles (‘three black crows’ pattern) which is a very bearish signal.
On the upside bulls need to push the price above $21.29, the low of 1st of March 2002, to create a ‘support turned resistance’ scenario. If that is confirmed it will open the door for $23.04, follow by $26.12, which was the low of 1st of February 2016.