11th May 2020 – (Hong Kong) With the oil price crashing to below zero on Monday in the U.S., many have been left wondering what next in the coming months amid the ongoing COVID 19 pandemic. That statement might be confusing if you are wondering how come you were charged for fuel at the gas pump; however, the crash occurred on WTI futures contracts.
The crash was caused by an excessive supply of oil since Saudi Arabia, and Russia wouldn’t agree on a production cut deal in March coupled with the reduction in demand as lockdowns around the globe intensified due to coronavirus.
Investors that were long on their oil futures contracts have had to deal with unprecedented losses as the WTI price index turned negative for the first time in history. The wrong turn of events meant that those who leave rolling over their contracts to the last minute had to settle for losses or less than they had paid to buy them in the first case, and that is the lucky few.
The crash didn’t affect only the US market; however, effects spread as far as Hong Kong, where the Samsung S&P GSCI Crude Oil ER Futures ETF saw its derivatives holdings fall by 26% as of Tuesday to US$378 million. And on Wednesday saw its traded units lose half of their value to close down at 46% at HK$1.79. This meant the ETF experienced its biggest drop and lowest drop since the commencement of trading in May 2016.
Oil Prices Could Rise
The crash has now forced a rude awakening to the oil industry as many shale oil producers cancel drilling plans. Some have been forced to shut down active wells entirely, and there is a chance some won’t survive at all.
Now the question is what next? Some experts believe that the rebalancing of the oil market might be so violently overdone it may set the stage for a spike in price soon. With supply slowing down now that Russia and Saudi Arabia agreed to cut production earlier this month, there is a possibility when demand recovers there won’t be enough supply to meet it.
According to Pavel Molchanov, an energy analyst at Raymond James, currently, we are in an epic burst, and as hard as it may be for many to believe, the next step is a boom. The analyst estimates that there are around 3.6 billion people currently under lockdowns around the world. Factories have been shut down, and passenger flights have been grounded.
According to the International Energy Agency, daily estimates, the world demand for oil is expected to plunge by a record 9.3 million barrels each day in 2020 as long as the coronavirus crisis is around.
That is why Molchanov believes when demand returns to normal levels or something close; there is a possibility there will be a shortage in the coming year.
Measures to Mitigate Oil Price Falling Further
Russia and other OPEC members have already agreed to cut the production of oil by a record 10 million barrels by the start of May. And with current market forces, other non-OPEC oil producers have been forced to follow suit.
The untimely collapse highlighted a foreseen problem within the oil industry. Since futures contracts require holders of the contracts to take delivery of barrels of oil when they expire, there was no investor in a position to receive oil, especially with storage locations running low everywhere. And even if you could secure a place to store your oil, the prices have skyrocketed.
The situation was so dire that holders of May contracts were willing to pay anyone to get out of their long positions to avoid physically receiving crude oil next month, according to Damien Courvalin, an analyst at Goldman Sachs in a note to clients on Monday.
Now oil supply must come down at a breathtaking pace to bring the market into balance, and this will set the pace of higher prices as demand recovers. Molchanov believes oil could trade at around US$50 and US$60 by next year or even higher than that.
Some experts argue that forced shutdowns for shale oil wells may cause problems when it comes time to turn them back on, which could limit the ability of shale companies in Asia and other parts of the world response to higher demand. Bankruptcies are also expected, as many companies won’t be around to turn the taps back on.
According to Rystad Energy, if oil prices trade at US$20, 533 oil exploration and production companies in the U.S. will file for bankruptcy by the end of next year. And even at US$30, more than 200 oil producers are likely to go bankrupt since most of them are unlikely to get the financing they need to stay alive.
So, when demand comes back, there won’t be many companies around to make the oil. Even companies that survive will be hesitant to increase supply lest they find themselves in the same situation again.