Oil: Where do we go from here?
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Oil has collapsed. So how did we get here?
Oil has fallen roughly 70% YTD, one of the biggest falls in history, as a result of a combination of supply and demand factors.
When Covid-19 was first announced the markets were hesitant about its impact and continued to trade as normal until it started to spread internationally and doubt first started creeping into its price. The rest is history, with cases spreading rapidly, the WHO declaring a pandemic and the world starting to take the virus seriously, introducing severe lockdown measures which unsurprisingly restricted economic activity, therefore reducing oil prices. What wasn’t helpful for oil’s case was the oversupply that preceded the virus. US shale producers had been saturating the market causing prices to fall and has been another factor exacerbating the fall in oil.
Read more: Brent falls too as oil fear grips the globe
Just as everything couldn’t get much worse for oil, OPEC and Russia failed to reach an agreement to cut supply in early March instead resulting in an increase of production to an already saturated market. Now this is where the issue starts to build, as with all of this new oil flooding into markets, storage capacity was going to be pressured. At these current production levels, storage was not sustainable and would require oil to be stored offshore on large tankers which was the reason why charges for hire of these tankers spiked as a result of demand. This was the push over the edge for oil, causing prices to plummet.
Following this, news of rising Covid-19 cases and the announcement of stricter lockdowns dragged prices even lower. Therefore, oil has been pulled down by both the supply angle as a result of political feuds and the demand side with low business and consumer demand. Airliners are grounded, manufacturing is weak and therefore there is no certainty over when oil will be required again, putting it against the ropes. A deal was always inevitable between OPEC and Russia which finally agreed to cut production by 10%, yet has failed to have an impact on price as future demand forecasts weigh on investor sentiment.
And now we are here, where WTI oil for the first time on record has hit negative price levels. This is largely a short-term cause due to storage capacity but nevertheless highlights the strange market dynamic we’re currently in. May WTI futures are approaching expiration meaning physical delivery of the asset awaits; therefore with no place to store oil, sellers are effectively paying buyers to take the oil off their hands reducing the burden of storage. When we look at June futures, these remain positive.
Where do we go from here?
As soon as we start to see evidence of economies returning to work and the economic cog starting to turn more efficiently again, this is when we’re likely to see oil prices starting to gain traction, however until then it’s a guessing game. Many will say that oil can’t go much lower but there is still downside risk in the fact that there may be a second wave of infections prolonging the demand requirement for oil which would further hurt.
It is clear the current production cut is not enough to maintain balance and is likely that a further cut will be announced however this does not change the demand side to this equation which appears to be the primary force behind oil prices. With still no clear signs of returning demand and economists forecasting one of the worst market pullbacks in economic activity in history, volatility in oil is likely to remain. Airlines are grounded, manufacturing remains weak and general business activity is still generally stagnant, therefore there is a still much uncertainty over when demand will return.
The path ahead remains gloomy for oil as signs of lockdowns easing are nowhere to be seen. Despite new case growth slowing, the caution over a second outbreak should economies reopen could prolong troubles for some time still, something that oil definitely doesn’t need right now. These events could well have a lasting impact on the commodity, which is commonly owned as a safe inflation-protected investment in portfolios and highlights the disruption and danger the combination of politics and oil can have.