Market Overview

17 March 2020

Oil Looks Less Supported at the Moment Than Shares

Oil prices recovered slightly this morning to the area above $31 per barrel on Brent benchmark, but they quickly slipped back under the $30.5 level. Any further gains could hardly be achieved after crude prices collapsed yesterday to a four-year low under $29.5.


Prices were regularly getting support in the early hours by Asian traders but the overall background remains quite negative. Goldman Sachs forecasts that through April 2020 oil demand could decline by more than four million barrels per day on a monthly basis and the forecast for Brent was lowered to $20 in the Q2 2020, while the Deutsche Bank lowered its forecast for Brent prices to $25 in Q2 and Q3 2020 on Tuesday. Bloomberg published the results of the experts' poll at the end of last week. According to the poll the demand for oil was estimated at around 100 million barrels per day in 2019. In comparison to recent numbers, the market may see a maximum drop in history as it may fall in average of more than 1 million bpd by the end of 2020,- which was last recorded in 2009 - or in the worst case scenario, it could drop even more than 2.65 million bpd, which was last recorded in 1980 during the world oil crisis. According to preliminary estimates by Singapore-based commodity traders from Trafigura, demand may contract by 10 million bpd in Q1 2020, and the same situation could be extended to the next quarter. "We haven't seen a demand event like this in history," said Saad Rahim, chief economist at oil trading giant Trafigura Group to Bloomberg. "Every day is going to be worse for demand for some time," he added.


All these figures of a likely decline in demand are huge, yet they seem to be within ten % of the total volume of the world's production. This should not lead to the collapse of oil prices by half, but it has already happened in the market. This could mean that in addition to the real fundamental component, a big virtual speculative game is being played. But all this overload of all sorts of information from the media may at least delay the recovery of the oil market and, on the contrary, drag prices deeper in the range from $25 to $28 for a short period of time, perhaps over the next few days.


Nevertheless, there is a positive background of information, which is worth mentioning.

Exxon Mobil announced that the company is considering reducing CAPEX (capital expenditures) which could mean they are not going to invest much in production amid the conditions of low oil prices. US President Donald Trump decided to increase oil purchases for strategic reserves, not only in an effort to protect the United States from possible supply disruptions due to the quarantine but also to take advantage of historically low prices. At the same time, he could intend to save many shale companies from the threat of future bankruptcy. If the US federal agencies buy at least some of their oil inventories to store in the federal reserves, that may also contribute to at least a small rise in prices. The total volume of purchases could range from 60 to 80 million barrels according to various estimates. White House economic advisor Larry Kudlow said the US administration plans to purchase nearly 75 million barrels of oil in an attempt to stop "the shenanigans and the destruction of the market". Perhaps, this is why the US Energy Information Administration (EIA) today reports that it expects a record high shale oil production in April. That is not good news for prices and, therefore, for the shale companies too. At the same time Libya reported that the oil production is about at halt with 91,000 bpd as the current production level.


Fundamentally speaking, some factors could support this barely outlined growth in oil prices. Even though they are consistent no one knows yet whether they will work at all. The current price levels look completely inadequate compared with the global balance of supply and demand, but the prices need a strong upside push to come back to a higher relatively equilibrium state. Those factors could be derived from a possible increase in the share of personal car usage, as during the current conditions people on all continents are trying to use public transport as less as possible. However, if the quarantine affects most of the countries with developed car markets, this effect could be limited. The important factor for sustaining price increase is to stop the decline in industrial oil consumption and to restart global production. The epidemic has already caused serious damage to the Chinese economy, and although normal life is gradually resuming there, now and again the pace of the Chinese economy will be certainly hit by the decline in consumption and demand in Europe, in the United States and all over the world. The normal functioning of industrial production in key countries is the main condition for a normal rate of recovery in commodity prices.


There is also a strong inertial and psychological relation between oil prices and the behaviour of stock indexes. Yesterday evening, the European stock exchanges did not recorder new lows of the week once again before the market closed. This morning they opened with a gap upward and even showed a slight increase in indexes in the first trading hour, but then they slipped below today's opening prices.


To help the markets, central banks introduced large stimulus packages and quantitative easing (QE) programs, buying their own countries' bonds like a snake eating its own tail. Altogether this was a synchronised move, they cut interest rates almost to zero levels and promised more easing if things get worse while governments promised to provide tax breaks or tax vacations to local companies. All these measures could potentially ease the situation, and at the same time, it may be clear that none of them will work directly to support market prices. As Donald Trump said: "the markets will take care of themselves." Yes, it's just what happens each time after a price crash, and the only question remaining is how soon will it take for this to happen given that Donald Trump himself recognised that the epidemic in the U.S., in his opinion, could surpass its peak by July or August. It may happen earlier as China managed the outbreak in two months, but the scenario for the rest of the world might be different.


Meanwhile the market headlines of the American media look a little more sobering. For example, the front page of the Wall Street Journal published an article today with the eloquent headline: "Extreme Volatility in Shares Isn't Due Just to the Pandemic" highlighting that "Computerized trading can dictate selling more simply because selling is on the rise". In this regard, temporary bans on short deals, which were introduced on a number of stock exchanges in France, Spain, Italy, Turkey, and earlier in South Korea and China, don't seem like such a bad idea. The ban may change at least the incoming data for the robotic trading programs.


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