InvestNow News – 22nd May – Antipodes – Outlook for Oil

8th May – Chris Connolly & Graham Hay

Who would have thought an oil price contract could go negative? This is in fact a reality that has unfolded over the past few weeks.

To understand the dynamic behind ‘negative oil’ we must look at the backdrop in which this had unfolded. The fight against COVID-19 has seen entire economies and communities shutdown, causing an unprecedented decline in oil demand. During the second quarter of 2020, we’re now expecting oil demand to be down around 15 million barrels a day (or 16% y/y). For context, during the worst period of the GFC we saw a draw down in demand of just under 3 million barrels a day.

But there’s been another major factor behind the oil price shock – the breakdown of the OPEC+ alliance.

As COVID-19 containment measures were just beginning to cripple economies in early March, the Saudi Arabia-led OPEC alliance failed to come to an agreement with Russia on oil production cuts. This prompted OPEC to lift all its own production limits as the worst of the COVID-19 crisis was hitting. This resulted in storage facilities filling rapidly, particularly in the US.

This has led to the unthinkable situation when WTI oil futures traded at a negative price.  The reason for this is somewhat technical in nature. WTI futures must be physically settled rather than cash settled with the delivery point at Cushing, Oklahoma, where all storage was either full or already booked out. Given they had nowhere to put the oil, buyers were unwilling to take the oil at any price.

The sell off in oil has largely been at the front end of the futures curve with little change in long term price expectations.  Indeed we believe the degree of capex cuts brought on by the recent price collapse will lead to significant shortfalls in supply and much higher prices in the medium term.  Our constructive view on the outlook for oil and oil equities is largely driven by what we think is an unappreciated contraction on the supply side.

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