Oil Supply Shock in the time of the Coronavirus
The large contraction in oil demand due to the spread of COVID-19 and the dissolution of the OPEC+ agreement has combined to generate large shockwaves through oil and financial markets. The impact on prices and balances has been severe with Brent and WTI falling by more than 50% over two weeks in March 2020. Daily Brent tumbled to $24.9/b on March 18 from $51.9/b on March 2, while at the same time WTI fell to $20.4/b from $46.8/b. Volatility has heightened and the market has seen some extremely volatile price movements. The market has flipped from backwardation to deep contango with time spreads reaching levels wider than those during the 2008 global financial crisis. According to our structural VAR model, the supply-demand imbalance is projected to reach 5.7 mb/d in 2020 and 3.3 mb/d in 2021 which will further deepen the contango as inventories continue to build and traders increasingly resort to floating storage. Combined with the increase in exports from OPEC+ producers, this has already caused a large increase in Very Large Crude Carriers (VLCC) rates. Concerns about availability of storage will continue to put severe pressure on front prices and the shape of the forward curve. Physical differentials have also come under severe pressure and there are reports that prices for some US crudes in physical markets have turned negative. The ramping up of exports by OPEC+ producers in the face of collapsing demand is already causing a massive shift in trade flows with oil exporters such as West African producers finding it increasingly difficult to clear their loading programs, forcing them to slash differentials and offer their crude at large discounts. In short, this is a market that is being tested to its limits and all previous records in terms of price movements and physical indicators are being, or are set to be, broken. This presentation sets out to examine some of the recent dynamics and producers’ behaviour shaping the oil market and their likely evolution in the next few months.