Macro: Sandcastle economics
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Will the EIA offer crude oil a glimmer of hope?
Ole Hansen
Head of Commodity Strategy
Summary: Crude oil has stabilized following the carnage that followed the collapse and move to negative prices of the now expired May. The short-term fundamental outlook however remains very disturbing given the potential need for more than 15 million barrels/day of forced shut-ins from producers around the world. The recovery led by WTI crude oil today has been driven by hopes that the EIA in their weekly inventory report at 14:30 GMT may show signs that the bottom in demand has been reached and on renewed hopes for a drug to fight the coronavirus.
What is our trading focus?
OILUKJUN20 – Brent Crude Oil (June)
OILUSJUL20 – WTI Crude Oil (July)
GSG:arcx - iShares S&P GSCI Commodity Index
DJP:arcx - iPath Bloomberg Commodity Index
XOP:arcx – Oil & Gas Exploration & Production
XLE:arcx – Energy Select Sector SPDR Fund (Large-cap US energy stocks)
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Crude oil has stabilized following the carnage that followed the collapse and move to negative prices of the now expired May. The short-term fundamental outlook however remains very disturbing given the potential need for more than 15 million barrels/day of forced shut-ins from producers around the world. The recovery led by WTI crude oil today has been driven by hopes that the EIA in their weekly inventory report may show signs that the bottom in demand has been reached. In addition the market has just received an additional boost from surging stocks amid renewed hopes for a drug to fight the coronavirus.
Once the world run out of facilities to store unwanted crude oil, production needs to equal demand. That can only be achieved by a major cut in production, not necessarily from the high cost producers, but primarily from those not having a buyer for their oil. Norwegian-based Rystad Energy in their latest report said they expects demand to drop by 28 million barrels per day this month; by 21 million next month; and by 16 million in June. Goldman Sachs in another report saw global storage facilities filling up within the next month.
The exodus out of the June WTI crude oil futures contract (CLM0) continued yesterday after S&P Global Inc., the company behind the most popular index (GSG:arcx) told clients to roll all their exposure out of June into July. The index which is tracked by billions of dollars in passive long-only funds such as pension funds normally roll their exposure between the 5th and the 9th trading day of the month. It highlights the risk that June could repeat the May move to zero as Cushing remains full. Another major commodity tracker, the Bloomberg Commodity Index (DJP:arcx) have rolled its exposure from July to August. The July contract shown below has found support at $17.50/b.
Faced with these expectations the rush by OPEC+ to cut production by the agreed 9.7 million barrels/day is on, and we can expect compliance being higher than previous attempt to curb supply. Adding to these barrels US producers are bleeding cash and the reductions already seen across the US shale oil patch is expected to rise further over the coming weeks. With these forecasts in mind we continue to see limited upside for crude oil until lock-downs are eased leading to a pickup in global demand or unfortunately, more likely that many producers, both high- and low-cost are forced to cut production, either voluntary or involuntary.
While prices used to settle physical transactions remain weak we have seen speculative demand drive the futures higher today. The sorry saga of the USO oil ETF has not gone away, but having been forced by regulators to roll their exposure further out the curve, the systemic risk of the ETF failing has eased. What unfortunately has not eased is the demand for oil futures tracking ETF's from novice traders with little or no knowledge about how the market function. An example being a US based trading platform, which during the past month has seen the number of clients holding USO positions almost rise by a factor 10 while the price of the ETF has more than halved.
Today’s better price performance has also been supported by a report last night from the American Petroleum Institute. In their weekly update, a precursor for today’s official report from the Energy Information Administration, they said that gasoline stocks declined by 1.1 million barrels last week. Perhaps an early sign that US motorists demand for gasoline has reached a plateau from where demand will start to recover.
Several data from the ‘Weekly Petroleum Status Report’ hit record levels during the previous few weeks. Gasoline stocks hit the highest on record (since 1992) while the four-week average demand collapsed to the lowest since the 1960’s. The lack of demand saw refineries produce at their lowest pace since 2008 while Cushing ,the storage and delivery hub for WTI crude oil futures, reached 60 million barrels. As it turned out with the collapse into a negative price the remaining 16 million barrels have already been leased and are currently not available.
I will post the result and market reaction to the EIA report on my Twitter account @ole_s_hansen
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