Tuesday, March 31, 2020

Crude oil prices to remain choppy in the near term

Oil markets are faced with a triple and not double whammy--Texas, Russia and OPEC.

Saudi Aramco said it will cut domestic refining to free up more crude for export.

Crude posted its biggest weekly decline with moves extending a week of wild swings for oil. The US crude slid below $30, continuing the previous week's rout as there seems to be no resolution to the war between Saudi Arabia and Russia. Saudi Arabia reported that it would ramp up output and slash prices with the week experiencing four days of massive selling. The selloff was followed by a market rebound when US crude posted its largest one-day gain in history after the U.S. reported that an envoy would head to Saudi Arabia to deal with fallout of a Saudi-Russia oil price war. Oil markets are faced with a triple and not double whammy--Texas, Russia and OPEC. Russia will not blink in its game with Saudi Arabia. Texas is getting a seat at the next OPEC meeting. The week’s drama in oil ranged from a battle of wits with WTI losing half its value in the past two weeks. Brent has dropped about 40% as the pandemic has cut demand at the same time as the collapse of coordinated output cuts by OPEC and Russia.

Recently, President Trump reported that he could intervene in the price war and that he was searching for “medium ground” to break the deadlock as he faces calls from lawmakers to help the domestic oil industry as low prices are threatening to hit the U.S. shale oil industry hard, jeopardizing the U.S. position as the world's largest oil producer. This gave market prices the much-needed lift albeit for a short period.

U.S. elected officials have urged the Trump administration to get involved after Texas state regulator spoke with OPEC Secretary General Barkindo about the possibility of a global production cut and it holds importance as Texas regulators have not intervened to cut output among state producers since 1973. But it looks like as far as a coordinated response with OPEC is concerned, it's hard to see a plan coming together along those lines.
Markets digested the reports from Russia after the Kremlin reported that Russia and Saudi Arabia have good relations when it comes to oil markets and Moscow does not need anyone to intervene. Reports suggest that Russian President Vladimir Putin is unlikely to yield to what he sees as “Saudi blackmail as Putin is known for not submitting to pressure.” Saudi Arabia reported to push its production to a record 12.3 Mbpd and booked shipments to send oil around the globe, refusing entreaties to rein in output. Global reports forecasted that demand could easily drop by 10 Mbpd or more. Vitol, the world's largest oil trader, said on Friday that global demand could fall by 10%.

Saudi Aramco said it will cut domestic refining to free up more crude for export. Remember, in Russia, fossil fuels and energy exports account for 64% of total exports. Its oil and gas sector covers 46% of total government expenditure and contributes about 30% to GDP. In Saudi Arabia, the petroleum sector accounts for roughly 85% of the kingdom’s revenue, 90 percent of export earnings and 42% of GDP.

In Putin-Salman standoff, markets are pondering over which man will blink first. With a fiscal break-even petroleum price of $42.50 per barrel, Russia’s economy is more diversified than its Saudi counterpart. It has a strong defense industry, the exports of which are second only to America’s. For Saudi Arabia, the fiscal break-even oil price is $85 per barrel, repor
ts the IMF. However, Riyadh’s foreign and gold reserves at $496.8 billion in September 2019 were higher than Moscow’s $419.6 billion. Further, Kremlin would still like winning some concessions such as an end to the US sanctions on Nord Stream 2 and Rosneft.
The US shale oil industry reduced its breakeven point from $65 to $46 a barrel. With oil now selling for $30, the Shale sector faces a renewed challenge. If this continues, many small, independent US drillers may be filing for bankruptcy because of their failure to repay loans from banks, which had accepted untapped oil reserves as collateral, thus fulfilling Russia's plan of Russia. With WTI in the mid-$20s, the shale industry is in a much more profound crisis. Prices may even go lower in the weeks ahead. Sector-wide spending cuts and mass layoffs are in the works. Bankruptcies are set to multiply.

For political reasons, Saudi Arabia cannot push the U.S. to join the club, yet reports have been insisting in recent days; there was a convergence of interest between Riyadh and Moscow on the issue. Financial Times, quoting a Saudi source close to the royal court, said it was in Saudi Arabia’s interests to “allow this thing to go on for a while to bring structural change to the industry”.

The global lockdown on worldwide travel and halted business activities continues to influence the oil prices. Oil prices are being battered from both sides; supply and demand. Demand for crude has cratered due to the coronavirus, which has pummeled everything from global manufacturing activity to travel. Even though gasoline prices have fallen, consumers trapped at home are in little position to take advantage. Meanwhile, central banks around the world are pushing liquidity in markets to fend off a recession after China was set to unleash trillions of yuan of fiscal stimulus to revive an economy facing its first contraction in four decades.

Markets cheered the news that the U.S. also said it would start filling its strategic reserves by buying 30Mbpd of U.S. crude. However, the amount of supply coming from OPEC+ in the coming months still dwarfs the decision by the U.S. to fill its strategic reserves.
Elsewhere, EIA data showed that U.S. crude stocks rose while gasoline and distillate inventories fell last week. Crude inventories rose by 2 Mbpd in the week ended March 13 to 453.7 million barrels, compared with expectations for a 3.3 Mbpd rise. Crude stocks at the Cushing, Oklahoma, delivery hub rose by 563,000 barrels in the last week. Refinery crude runs rose by 118,000 barrels per day in the last week, EIA said. Refinery utilization rates were unchanged on the week. U.S. gasoline stocks fell by 6.2 million barrels in the week to 240.82 million barrels, the EIA said, compared with expectations for a 2.9 Mbpdl drop. Distillate stockpiles fell by 2.9 Mbpd in the week to 125.12 million barrels, versus expectations for a 2 Mbpd drop.

Natural Gas:
Natural-gas fell to their lowest levels since 1995 on Wednesday, weighed down by a reduction of foreign demand for U.S. industrial exports such as liquefied natural gas and an expected drop in power generation and demand as businesses close.

For this week, we expect some wide swinging choppy trade going forward rather than the one way ride south seen during the past couple of weeks. Neither Saudi Arabia nor Russia are currently backing down from the oil price war, but the one who blinks first will likely be the one whose finances will be hurt more. Is Tropec — Texas-Russia-Opec — in the making? To many, that is the best option available at the moment. In a fragmented crude world, with multiple power centers, nothing seems impossible at this juncture. The supply cuts would remain much too small to offset the current 8 mb/d hit on demand from coronavirus and wouldn’t prevent unprecedented inventory build over next month which could still saturate local logistical capacity and push prices to cash-costs.

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