Market Overview

1 April 2020

Oil Prices May Reach the "Bottom" Even in April, But It May Be Quite Deep

Commodity markets are suffering from much stronger pressures than stock prices. It seems that the investment community has some kind of consensus understanding that most "blue chips" and just "too-large-to-fall" companies would be able to restore somehow almost the same level of their revenue and income when the story with quarantine crisis finally ends. But raw material prices represent a different layer of reality. They could remain high or quite low for a longer time depending not only on the dynamics of world production demand but also on the specifics of the supply. That is not only the volume of production or exports but also due the nature of the supply. Most of the producers are members of cartel agreements or they are engaged in chaotic price dumping and they are trying to win a fight against all others and secure their place under the sun. Some countries are under sanctions by the US and still trying to outwit them with huge losses and by offering even lower prices to those who are ready to play hide and seek with the States.

After the deal between The Organisation of the Petroleum Exporting Countries (OPEC) and its allies that lasted for more than three years and completely collapsed in early March, oil prices have plummeted and they abide now somewhere in the pandemonium. The pandemic crisis has caused a huge drop in industrial and personal demand, as there are very low fuel needs for transport companies, is accompanied by an unusual situation for the oil market when all producing countries considered themselves completely free from any obligations on the production side. Strictly legally speaking, the deal between OPEC and allies existed until April 1 but in fact oil producers pushed the boat overset much earlier.

The struggle for elusive customers has led Saudi producers, for example, to make discount offers at once from five to even seven Dollars per barrel below the bottom of the market. Some of these proposals were later revoked by sellers as they did not calculate the soaring costs of fuel transportation by oil carriers. While the "official" market price of West Texas Intermediate (WTI) oil hovers around $20 per barrel trying to break even down below the price of Russian Urals oil in North-Western, Europe has fallen to $13 per barrel already, according to Argus Media Agency data. The Urals crude price fell by another 3.2 Dollars per barrel since last Friday.

This situation was generally beneficial for regions that do not produce large amounts of oil themselves, for example, for most of the countries in Europe and Asia, as the extremely low gasoline prices have partially reduced the manufacturers' expenses and supported the declining economy. But even for the pure importers of hydrocarbons the situation doesn't look very bright in a long-time horizon as oil producing companies face increasing difficulties with reasonable returns on their investment. Most oil producers have cut any development projects and this may lead the world to an oil deficit later on. With ultra-low demand now that seems like something incredible, a future lack of production and refining capacities may be alarming. That alarm is beginning to ring through not only the US shale companies, about a third of which have a high chance of simply going bankrupt under the weight of their leverage, but also through traditional large oil producers in Texas.

US President Donald Trump rushed to have a phone conversation with both the Saudi Prince Mohammed bin Salman Al Saud and Russian President Vladimir Putin. Trump announced on Tuesday that the three main oil-producing countries would jointly seek a way out of the situation on the world markets. He noted that the collapse of prices for the "black gold" has already led to the fact that in some countries water has become more expensive than oil. The US president said earlier that he doesn't want to see the American energy sector "wiped out" after Russia and Saudi Arabia "both went crazy" and launched a conflict that depressed oil prices. "I never thought I'd be saying that maybe we have to have an oil increase, because we do. The price is so low," Trump said in an interview on "Fox & Friends." He acknowledged that to some extent low oil prices are a boon for Americans. They can buy fuel for little money, as Trump was keen to before when oil prices were above $70 per barrel. Low fuel prices are good for airlines and other large crude consumers, but extremely low crude prices may lead America to lose its entire oil industry, which gives thousands and thousands of jobs.

Obviously, there will be some negotiations between the US representatives, Saudi and Russian oil industry decision makers. But could this noticeably support oil prices in reality? For example, in Saudi Arabia decisions on oil are made by a narrow circle of reigning persons and in Russia there is a so-called "vertical of power", where the leaders of oil industries are probably under strict control of Vladimir Putin. The state has a controlling stake in the oil industry in both Russia and Saudi Arabia. The President of the United States, on the other hand, does not have the power to order big private oil companies like Chevron or Exxon Mobile around and tell them what they have to do regarding inter alia production plans. He can only ask them about some possible steps, or make a request to them, but does Trump have the leverage over the management of these companies? There are serious doubts about this. Most likely, some representatives of these giant companies would be a party to the negotiations from the US side, and not the White House team.

But let's imagine that Texas producers want to negotiate. Then what exactly should they talk about with the Russians and the Saudis? It would be optimal to agree simply not to dump, but to negotiate the lower price level, below which no one falls. Russians are also seen reluctant to negotiate with Saudis as they turned away the extension of the recently existed deal Russians hoped OPEC would support. Discussing plans to cut production with any specific figures of volumes in terms of the impact on prices is not productive at all now. It is precisely because the expectations of one or two more waves of price movement down exists not only of the broad market "crowd" but also one of solid large funds. The appearance of a clearly visible peak in the dynamics of infected people in the countries with the largest economy is desperately needed for many oil traders as an important confirmation signal to really start looking upside. The markets probably need "a certificate from God's own office" that reasons for quarantine begin to fade.

For today, as a basic or even the best option for the economy, it may be considered that the measures of forced self-isolation in Europe and in the US could finally expire by April 30 and then it could be expected to get out of the current stage of complete stagnation in the service sectors and production. The March PMI index in China, that has quickly recovered from 37 to 52 level, provides a good example of how fast things can change when the process is already underway. But it needs at least to begin. Some Chinese manufactures have increased US crude purchases with some buyers snapping up cargoes at the widest discounts ever as sellers seek to offload excess supplies in Asia, several trade sources said to Reuters on Wednesday. But Asia alone is not expected to make the oil market weather normal, because the production there cannot grow quickly amid the fact that the rest of the world is closed and there is no place to export to.

It's clear that the global pause is not eternal and the world will restore both production and supply chains. This means that the "bottom" point for oil is probably not far away in terms of timing, but this "bottom" point may be much deeper in terms of price than even the most pessimistic expectations suggest. Therefore, the main question is not in numbers of how many Dollars per barrel will be there at the "bottom", but how long could the entire process of recovering take? There is still a real chance to see the lows in the commodity markets around the second half of April. The real "bottom" of prices could be spotted only after the peak of virus infection will pass not only in Europe, but also in the United States. It will be the moment that may finally give oil traders more or less clear confidence in the timing of when exactly the production in the main fuel-consuming countries will be gradually opened by the authorities after the quarantine.

However, even after this happens it may take additional two or three months at least to reach the levels of consumer activity that would be close to normal. That would allow restoring an ordinary level of consumption of petroleum products that was before the virus squeezed world economy. The current oil prices include the basic scenario expectations to have the "bottom" updated at some much deeper level, up to $15 per barrel for Brent and maybe even lower, and the second part of the same basic consensus market scenario is that the oil market then may be doomed to a serious rebound at least to $45-50 area. Even if the toughest forecasts come true, such as a temporary decline in demand by 20-25 million barrels per day in Q2, that is almost a quarter of the total world production decline, this hole in demand may be a short-lived wound that may heal in Q3 and Q4 of 2020.


Analysis and opinions provided herein are intended solely for informational and educational purposes and don't represent a recommendation or investment advice by TeleTrade.

Lysakov Sergey
Market Focus
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