By Barani Krishnan and Geoffrey Smith
Investing.com - Oil prices finished a wild week on a calmer note Friday, ending down about 4%, compared with the astonishing moves in earlier sessions.
U.S. prices dived into negative territory for the first time in history this week amid concerns that there is not enough global storage for a growing glut in a market already hit by collapsing demand amid widespread lockdowns and travel bans due to the coronavirus pandemic. But rallies of more than 25% recovered some of the damage. Brent finished the week down more than 20% as demand destruction from Covid-19 still greatly outweighs any planned cuts in production.
What does the oil market hold for investors now? Barani Krishnan lists three factors for why the bearishness will persist: storage, fear of negative prices and slow production cuts. Geoffrey Smith counters that demand has bottomed and that storage constraints could actually lead to more permanent supply cuts. This is Point/Counterpoint.
The Bear Case
Oil Storage
Fear that the U.S. will have no room to store all the oil it's producing is what drove WTI negative this week.
And the elephant in the room remains oil storage, which, to continue the animal kingdom metaphor, is about the size of a mouse and shrinking.
According to the Energy Information Administration, there's about 16 million barrels or fewer of space left at the Cushing, Okla. hub that serves as delivery point for expiring WTI contracts. Total builds in U.S. crude have, in fact, averaged 16 million barrels per week over the past four weeks. Of course, not all that oil will come to Cushing. But the hub saw a 5-million-barrel build last week. If that rate of fill is maintained, then Cushing could max out in three weeks.
Yet even this math may be academic, as the EIA indicates that much of the space at Cushing may have already been leased out, making the likelihood of space there even smaller.
Fear of Negative Prices
What happened to May WTI could also happen to June WTI, as there appears to be little incentive for investors to stay in the front month and support it through expiry.
As of Friday, the June contract was at a discount of $5 per barrel, with 25,000 lots less in open interest to July. This signals the preference of investors to be in a “safer” contract that pledges to deliver oil later rather than sooner in a glutted market. It also signals that June also could be up for a squeeze when expiry approaches less than a month from now. If that happens, the spot contract is likely to plunge to subzero levels again.
Cuts vs. Time
OPEC and other global oil producers have committed to cut at least 9.7 million barrels per day from May 1. Kuwait, OPEC's fourth-largest producer, says it has already begun cutting ahead of the group. So has Nigeria, because there's just nowhere to put any more of its oil.
U.S. drillers have shed hundreds of rigs within the last few weeks and capital expenditure cuts could take away many more barrels across the world.
But all this may not be fast enough in a world losing between 20 million and 30 million bpd in demand. Time is of the essence and it's not on oil's side for the moment.
The Bull Case
The fundamental bull case for oil from here is that demand has already bottomed. The trajectory for oil consumption from here on is upward, no matter how gradual, no matter how uneven.
In China, the rebound is already happening. Data from satnav firm TomTom show that morning rush hour congestion was very nearly back at 2019 levels in the last week – a fact that contrasts squarely with all the chin-stroking prophets arguing that Zoom, Houseparty et al will permanently destroy commuter demand.
While there is uncertainty over the future of commuting, the argument can also be made that distrust of public transport will push at least some commuters back into cars.
The International Energy Agency’s monthly report for April estimated demand will bottom this month at 29 million barrels a day below year-earlier levels. That shortfall drops to 26 million barrels a day in May and 15 million barrels a day in June.
The expected June shortfall reflects the 9.7 million barrels a day of output cuts promised by the OPEC+ group of exporters from May. The risk of political instability across that group creates a permanent incentive to keep prices high and has ensured for 50 years that previous breakdowns of output discipline have only ever been temporary.
On top of that, U.S. production which has so far only ticked down modestly, will soon be tumbling. Active rigs in the U.S. have fallen by nearly half since the start of the year, down by another 51 this week alone to 378, according to Baker Hughes. Producers are slashing capital spending and production forecasts with increasing urgency (including ConocoPhillips (NYSE:COP), Continental Resources and Eni SpA this week). Government data indicate that there are only 16 million barrels of free storage at the national hub at Cushing, Okla. When they get maxed out in three weeks time, assuming stocks continue to build at current rates, there will be nowhere left to put it. Marginal fields will have to be shut in.
On top of all that there is the reality that the world isn’t done with oil by a long stretch. No reasonable forecast sees global oil demand peaking until 2040 at the earliest.