From Global Risk Management
The Oil Market Quarterly Outlook April'20
In the Quarterly Oil Market Outlook we look at fundamental, geopolitical and financial influence on oil price development over the coming quarter and we find that the coming period could continue to see heavy oil price volatility as coronavirus pandemic and oil price war remain in centre stage.
In the short term, we expect oil prices to remain low as oversupply and lack of demand rule the oil market, but later this year, demand is expected to pick up as the world heads towards "normal" following the coronavirus pandemic effects and potentially a production cut deal between major oil producers which will likely result in increasing oil prices. At time of writing this outlook, there is some news suggesting this production cut might come soon, but the volume and timing remains uncertain right now. With potentially 15-20 mio. barrels per day drop in global demand for oil due to the coronavirus pandemic, the world would need a substantial production cut, even if some production is absorbed by filling strategic reserves around the globe.
The last quarter has seen some of the most volatile times in the oil markets in recent history as the coronavirus has affected global demand for oil while tensions between large oil suppliers have contributed to large changes in supply. In this section we will focus on the main factors affecting both supply and demand in these volatile times.
The price war might have large consequences for other suppliers as well as the main actors in the conflict, Saudi Arabia and Russia. Other OPEC members such as Iraq, Algeria, and Nigeria whose economies are highly dependent on exports of oil might be affected largely by the current price levels.
As we will also emphasise in the geopolitical section later on, the massive decline in oil prices during the last quarter could also have huge consequences for U.S. shale producers. As a result, many U.S. producers intend to cut spending which among others means that they stop drilling plans in order to preserve capital. The graph below illustrates the number of rigs in the U.S. which has been decreasing in the past year. Numbers from March indicate a plunge in U.S. rigs and so it seems that U.S. producers are cutting production at a rapid pace. Therefore, we expect to see a decrease in the supply levels from the U.S. in Q2, a nation that has grown into being the largest producer in the world in a time where OPEC+ nations have implemented production cuts which is reflected in the graph above.
As supply levels are currently not adjusted to the low demand, large amounts of oil will have to be stored and inventories have been rising in 2020 so far and will likely continue to increase in the coming months. The numbers are quite extreme as supply as of late March is above demand in levels around 20 mb/d which means that inventories are building fast. From the graph below, it becomes clear that U.S. crude inventories already have been building since the start of 2020 in a time where demand wasn’t as low as we are seeing right now.
Inventories could rise to such high levels that storage capacity will be full shortly according to the head of International Energy Agency, IEA. This creates another problem, namely that producers will not have any place to store their oil with some parts of the world more affected by this matter than others. If inventories fill up, supply levels will have to adjust even further as many producers will not be able to dispose of their production. As storage capacity is projected to be full within short amounts of time, the demand for floating storage has increased lately which we will touch upon later.
The first quarter of 2020 also saw multiple sanctions from the U.S. on a Russian oil giant, which is the largest exporter of Venezuelan crude oil. The sanctions came as a consequence of the company’s continuing alliance with the regime and the country’s president. Sanctions from the U.S. of this sort might have a tie to the above-mentioned price war. As a result, we have seen a large decline in exports from Venezuela in the first quarter of 2020 as can be seen on the graph below. The data show an overall decline from late February which is due to earlier sanctions from the U.S.
In a time where some of the world’s largest producers will likely open the oil taps, the global demand has declined significantly in the recent quarter due to the coronavirus. The situation has been developing on a daily basis in the last weeks with high uncertainty about the spread of the virus taking centre stage. The recent restrictions in most European countries and the U.S. add to the already decreasing demand observed in China where the virus originally spread from. As of late March, demand could be down as much as 20 mb/d, according to IEA, as almost 3 billion people around the world are locked down.
The effects of the coronavirus will result in a decrease in global oil demand in 2020, the first full year decline since 2009, according to the IEA. The forecast predicts a decline in global oil demand of 90 kb/d, however, this number is from early March and most likely will be adjusted given the coronavirus development.
The downturn in demand arises as most economies are almost completely locked down to prevent the coronavirus from spreading further. Especially travel has been affected following travel bans by many countries which have led to most international flights being cancelled around the world. As a result, demand for jet fuel has plummeted in the last month by almost 75% or around 5 mb/d. With most planes grounded, business and factories shut down, and many people forced to stay in their homes, the economy has been brought close to a standstill. This also means that the demand for gasoline is lower as drivers are in no need to use their cars. In the U.S. a large amount of the 9 mb/d demand has vanished as many states are locked down, a pattern which is also the case in Europe and Asia. Furthermore, also India has decided to implement a lockdown that for now will last until mid-April which affects around 1.3 billion. This will also have a major effect on the country’s demand for oil.
The very low demand for fuel has affected many refineries around the world turning crude oil into diesel, gasoline, and other fuels. This has caused several refineries to lower production of these types of fuels and some refineries have even been forced to shut down.
Since China accounted for 80% of the world’s demand growth in 2019, the first quarter of 2020 where large parts of China have been locked down will naturally hit the demand for oil and will show in the growth factors. Estimates from the IEA for Q1 2020 is a drop in global oil demand of 2.5 mb/d where China’s demand is decreasing by 1.8 mb/d. As the coronavirus has spread all over the world, China seems to have contained the virus and starts to slowly open up the economy again. In mid-March Chinese students slowly returned to school and offices and shops started to open again in many parts of China. The situation in the Hubei province is still serious, but other parts of China are slowly beginning to open.
The sooner the Chinese economy gets back to normal standards, the better outlook for demand. How long such a transition period will take before the nation is back to normal is difficult to predict and depends highly on the strategy laid out by the government which would be cautious not to open too quickly and risk a setback if the coronavirus was to start spreading again.
As oil prices have declined massively in the first quarter of 2020, the market has also moved into a deep contango with forward prices significantly higher than spot prices. This could open for a strategy to buy oil now and store it, only to sell at a higher price at a later stage. With the significant contango we are observing in the market, this trade has indeed become profitable according to some of the world’s largest trading houses. This could support demand if it is possible to find storage for the oil that is building quickly and causing the increase in floating storage described earlier.
The outlook for global oil demand is very uncertain at the moment and depends highly on the effectiveness of governments' efforts to contain the virus around the world. The question regarding oil demand depends on how long the world will be locked down due to the coronavirus, but nevertheless we expect a significant decrease in demand for oil in 2020.
As a roundup, connecting the expectation of lower demand together with the oversupply of oil into the market rises yet another issue which is the fear of a large glut as maximum capacity on conventional oil fields is reached. As conventional producers have nowhere to store their oil they could need to fully stop their production. If this happens the first impact would be even lower oil prices. The second impact we might see, after the initial lower prices, is undersupply of oil going into Q4 in 2020 (assuming that the economy gets going again in Q2), as producers will experience trouble in catching up to production levels seen before their shutdown and thus having trouble in supplying the equal to Q4 demand levels.
A fine analogy to understand this concept is; Imagine a fully inflated balloon, depicting the oil fields, and imagine you keep inflating air into the balloon, as producers are doing at the moment. At one point the balloon will burst, but as long as you keep blowing air into the balloon it will stay inflated. On the other hand, if you stop blowing air into the balloon, to only start inflating again at a later time you’ll have big problems trying to inflate the balloon to earlier volumes. This is the scenario in which the conventional oil producers finds themselves and it could indicate that we might see higher prices towards the end of the year.
The situation in fundamentals is characterised by an extreme case of oversupply and declines in demand due to increases in production by Saudi Arabia and Russia following their price war as well as lower demand all over the world due to the coronavirus. We set the fundamentals to be bearish in the short term and expect the high volatility in oil prices to continue into Q2 of 2020. Dark horse to this is a potential development in production cut agreement between the parties - timing and volume remain uncertain.
"We set fundamentals to bearish in the short term"
As was the case as regards fundamentals, coronavirus has also been the main contributing factor to the developments in financials around the world as governments and central banks have used lots of tools in an attempt to stimulate the economy. In this section we will go through the highlights of financials in both the U.S., Europe, and China to emphasise what consequences the financials have on oil prices.
Growth and production figures
To start off, we will focus on growth in the gross domestic product (GDP) for the U.S. Up until 2019, we saw a lot of volatility in the U.S. GDP with values ranging between 1% and above 4%, but throughout 2019 U.S. has managed to keep GDP growth at a rate of around 2%. The more stable growth rate in the economy might come as a result of actions carried out by the Fed as we will elaborate on below. However, despite the more stable growth rate in previous quarters, we might see a significantly lower growth if not a contraction in the coming quarters due to the coronavirus. As the number of coronavirus cases in the U.S. has exploded in March, fear of a recession is high which will most likely be showing in the growth rates in the coming quarters.
Another good indicator for future growth in the economy is the purchasing managers’ index, also known as PMI. As can be seen from the graph below where we have illustrated the critical level of 50, the PMI in the U.S. showed signs of improvement in early 2020 as the level moved above 50 after several months below. However, as of February the PMI decreased again to around 50 and the recent uncertainties in the economy will probably show in the coming months’ PMIs as companies are laying off workers and spending could decrease significantly.
As mentioned above, the current state of the world will affect companies significantly because businesses will have to be kept closed and people are isolated in their homes. This is going to have great impact on the unemployment rate as many workers will likely be laid off, simply due to the fact that their jobs can’t be carried out. The unemployment rate in the U.S. has been at record low levels recently which is showed in the graph below. However, we expect to see a rather steep increase in the unemployment levels as many Americans have filed for unemployment claims in March. A record high of 3.28 million Americans registered as unemployed in week 12, an increase of 3 million compared to the prior week's number of 281,000. The number was by far the highest ever, surpassing the previous high of 695,000 in October 1982.
With the fear of recession looming following effects of the coronavirus, the U.S. Federal Reserve (Fed) is doing everything within its power to support the economy. The recent quarter has seen multiple interest rate cuts from the Fed. The Fed decided in an unanimous vote on March 3 to cut the Fed funds rate by 50 basis points to a range between 1% and 1.25% in the first emergency action since the financial crisis in 2008. Again, later in March, namely March 15, the Fed decided to cut the benchmark interest even further by a whole percentage point to a level between 0% and 0.25%, the lowest level since the financial crisis in 2008. Along with the interest rate cut, the Fed also announced that it will boost the bond holdings by at least $700 billion to support the flow of credit in the economy, according to the Fed chairman Jerome Powell. The question remains if the actions from the Fed will be enough to get the economy up and running again.
The effects of the coronavirus are indeed showing in stock markets with large declines all around the world, some larger than during the financial crisis in 2008 in a much shorter timeframe. If we look at the S&P500 index in the U.S. illustrated in the graph below, we see a massive decline from mid-February continuing to the time of writing. After stimulus from governments and central banks around the world, markets seem to have found some support and have in the recent weeks climbed a little bit again to cover some of the losses. In the U.S., it appears the actions from the Fed have stopped the bleeding for now. The state of the economy in the coming quarters depends highly on whether governments will be able to contain the virus and get the economy back to normal.
Growth and production figures
We will in this section focus on the financials in the European region and look at the same economic factors as we did in the U.S. Starting with GDP growth, we can see that Europe has suffered from declining GDP growth since 2017 as is illustrated in the table below. In Q4 2019 Europe again saw declines in both YoY and QoQ growth with almost no growth for QoQ.
The coronavirus is expected to have major impact on the European economy as especially countries in the southern parts of Europe have been hit by the coronavirus. Italy has early struggled with large amounts of cases and deaths while Spain has seen a large increase in cases throughout March. Many of the large economies in Europe have been affected massively lately as Germany, France and Great Britain also have seen numbers rise.
When looking at the PMI for Europe, positive numbers have come out in the first months of 2020 as the level rose towards the benchmark level of 50, which is indicated by the light green line. However, as for the expectations going forward, we expect to see a contraction in the European economy amidst the coronavirus is still not under control.
When looking at the unemployment rate in Europe, we see a pattern like the one in the U.S. with declines from 2018 to the time of writing. However, the level is at a higher than rate observed in the U.S. standing almost twice as high. The decline in the unemployment rate is a positive sign for European economy that is looking rather sluggish on other parameters. However, the level is higher than in the U.S. which also shows more stable growth in other parameters. The unemployment is likewise expected to increase heavily in the coming months with many European countries locked down because of the coronavirus.
In the graph below, we have illustrated the interest rate development of the European Central Bank (ECB) which shows a refinancing rate of 0% and a negative deposit rate of -0.5%. This shows the ECB’s attempt to stimulate the European economy throughout a longer period, but the effects seem, from the earlier described data, to be missing. After the coronavirus outbreak, the ECB has taken significant steps to support the European economy by implementing several emergency purchases programs. The first program of 120 billion euro was initiated on March 12 while the second from March 18 was at a larger amount of 750 billion euro. Head of the ECB, Christine Lagarde, further announced that the ECB is ready to increase the sizes of these purchase programs if necessary. The ECB is taking extreme measures to support European economy.
Growth and production figures
As mentioned in previous reports, the Chinese economy has been growing at a slower pace for a period and data from Q4 2019 indicates that the decrease is stagnating around the level of 6% YoY. As with most of the other financials in the world, also China’s growth is expected to decrease, especially in Q1 where the coronavirus forced the country to go into lockdown. As the Chinese economy slowly begins to open up again, they might be over the worst of the virus and the question is how much time it will take to get the economy back to normal. However, we expect also Q2 numbers to be affected by the coronavirus.
The early effects of the coronavirus impact on Chinese economy are showing in the Purchasing Managers Index (PMI) for China which decreased from a stabile range around 50 to around 35 in February. If we compare the PMI from China with the other values from the U.S. and Europe, it becomes clear that Chinese economy was hit before other parts of the world, naturally as the virus spread from there.
With the U.S. still above 50 and Europe with an increase in PMI for February, the Chinese economy might have been through the worst as the country seems to have the virus under control as the number of cases and deaths are slowing down. However, the rest of the world, especially the U.S. and Europe are struggling to contain the virus at time of writing with U.S. passing the numbers of cases from China as of March 26. In the coming months, we will be able to observe how the Chinese economy recovers from the effects of the virus and how long before the economy is back to its feet.
In the first quarter of 2020 the USD/CNY increased slightly again after a quarter of overall decline; illustrated in the graph below. An increase in the currency pair makes commodities more expensive when bought in dollars and this could be barrier for growth in Chinese demand for oil. With China being the largest importer of oil, a strong currency might influence demand. However, the levels we are seeing now are rather stable around 7 and the currency is not expected to be the main reason for a possible decrease in demand.
As the major economies around the world are massively affected by the coronavirus which has shut down most countries, central banks and governments are doing everything in their power to support the economy. With Europe already heavily affected and Chinese growth slowing down, the coronavirus will hit all economies. Whether interference from governments and central banks will be able to get economies back to normal within a short timeframe remains uncertain and the question remains how long before economies recover from the recession created by the coronavirus. With this in mind, we set the financials to bearish.
"We set financials to bearish"
The Saudi / Russia oil price war
In the following we will elaborate on the development of geopolitical issues, mainly the development within the OPEC+ and the ongoing price war at a time of crisis.
In the midst of one of the largest crisis’s in modern times a battle of two oil giants is taking place as well. For the last three years both Saudi Arabia and Russia, along with other oil producers, have been working together in order to prop up the oil prices and balance the oil market. On March 9 that cooperation seemed finished, when the oil prices crashed sending Brent down by 20% and trading in levels around $31 a barrel from $45 a barrel. The crash came after Saudi and Russia failed to agree on further output cuts. Instead Saudi made it clear it would increase production and so the price war seemed to have begun.
There are mixed reports on why events happened as they did, some suggesting the breakdown of talks happened on a hunch of disagreement, while others claim that the breakdown was planned. The Saudis generally need a price of $82 a barrel to balance its budgets, while the Russians need a price of just $42 a barrel to do the same. Both need a price far above what we are seeing currently, which indicates that endgame for both giants is something entirely else than oil productions cuts and higher prices. Russia specifically has been outspoken in the displeasure of production cuts, as U.S. shale producers have benefited from the higher prices, while they have not cut production themselves.
The fundamental axiom of higher prices is that while it leads to greater profits for the producers, the degree of competition also increases with higher prices. Both Russia and Saudi have indicated that they can sustain very low oil prices for an extended period of time, something that smaller oil producers and shale- producers cannot. Reports have suggested that 70% of U.S. shale producers face bankruptcy with sustained low oil prices. That is also why we have seen U.S. shale producers urging the U.S. administration to intervene.
At the moment it is uncertain if there are ongoing talks between Saudi and Russia to make a production cut deal, however both countries are under political pressure from the rest of the world to stabilise the prices. The future holds uncertainty, and even though a deal might be struck, the demand shock for oil due to coronavirus is luring as a dark sky over the political landscape and a change in supply from the OPEC+ members would maybe not be enough to stabilise the prices anymore.
"We set geopolitics to bearish in the short term"
Oil price forecast (average)
Please note that the forecast is the AVERAGE price per quarter. Thus, prices during the quarter will likely be both higher and lower.
How is the report structured?
The report is divided into three parts – each part elaborates on three main topics which are influencing the oil prices:
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