Marius Paun | London, UK | Senior dealer | Tuesday, 28th April 2020
After turning negative for the first time in history last week, crude prices have recovered slightly. However, many investors remained unconvinced that a coronavirus-led slump in global demand is likely making a comeback anytime soon. This alone could keep the price of oil, and currencies of oil-producing countries, under pressure. Yesterday, the US oil benchmark, West Texas Intermediate (WTI) for June delivery plunged 25% to close at $12.78 following heightened concerns the worldwide storage would soon be fully utilised.
The reason for negative prices was the technicality of rolling from May contracts to June which we discussed in the previous reports. It was reported by Forbes that The United States Oil Fund, an exchange-traded fund (ticker USO) popular with retail investors, held about 25% of US oil futures last week. That ETF does not take delivery of physical oil but rather wants exposure to oil price through future contracts. So they had to sell May contract coming close to expiry no matter the prices. Furthermore, to avoid a repeat of the same negative oil prices, beginning with Monday 27th April they announced would sell all of its June delivery contracts in favour of longer-term contracts. The worry now is that the June contract will face the same fate as May’s. Especially when Bloomberg claims that according to oil companies ‘it’s better to sell oil at a negative price now and keep pumping rather than having to cease production now and ramp it up again later’.
There were also ongoing fears that storage scarcity is not going away either. For example, the oil hub at Cushing, Oklahoma may reach full capacity soon. US crude inventories rose by 15 million barrels to 518.6 million barrels in the week to April 17 near an all-time high record of 535 million barrels set in 2017. Cushing is the delivery point for WTI and is now 70% full as of mid-April with all available space already leased. Elsewhere, onshore tanks in most parts of the US are almost full and the rest of the world is not far behind.
The fact of the matter is that right now the world is awash with crude oil. It is true that coronavirus has made the situation a lot worse, but underlying issues have been brewing for some time. It takes time to find oil and then produces it. Just think of it, time to get permission to explore, start exploration, you may or not find it, time to get a permit for drilling, start digging and finally move it to the point where you actually need it. All of this is showing that the oil industry is grossly out of sync with oil price cycle most of the time. When suppliers see prices moving a lot higher, they try to produce a lot more to take advantage. Eventually, a glut is formed as massive supply comes in at once. Prices collapse, producers cut back production. In turn, demand overtakes supply which pushed prices back higher and the cycle repeats.
What was rather different this time was the nascent US shale industry made possible when oil prices moved above $100 per barrel. Even if many of them still don’t make any profits, something kept them going and adding to the supply – probably the attraction of low-interest rates and cheap, available credit.
There are also geopolitical factors. Thanks to its specific geology, Saudi Arabia has the lowest cost of oil production in the world. But even Saudi Arabia cannot control demand. The Covid-19 has clearly destroyed a good chunk of that as it is estimated that 40% of oil demand accounts for people driving around. However, perception is that Saudi may try to turn the new status quo to its advantage and crush the competition in the process. Apparently, there are over 40 million barrels of oil heading to the US right now to fill what remains of the storage capacity which no one needs because hardly anyone is driving. Similar quantities are heading into Europe and Asia. The US President Donald Trump threatened to ban or apply hefty tariffs on Saudi crude. But what if in retaliation Saudi Arabia break their peg with the US dollar – the so-called petrodollars understanding? Could it get that nasty?
The chart above indicates that sellers remain in control and after a dead cat bounce the downtrend seems about to resume. The short-term moving averages are still below the longer-term ones, both pointing downwards and the price below both indicators.
On the downside, we saw a low of $6.5 reached on April 21st which the bears would look to retest. For the past three sessions, the prices found good resistance at the 6 day moving averages. Being unable to break above it has attracted additional selling power which has completely denied the previous meagre recovery. For now, it does not look like the danger of more negative prices has completely passed.
On the upside, bulls would need to see a close above $13.21 first. A rally back above $18.26 the high April 23rd would also signal the short term rebound still has legs. Resistance at 22.79 which is close to the 21 days moving averages would be the next upside target as it acted as good support on the way down since mid-March.