Unrestricted Thoughts - The oily issue


Known as the ‘black gold’, the view has always been that demand would never fade away for oil and hence the possibility of the futures market going to negative levels is unthinkable.But the notion of oil being a safe bet for trading purposes obliterated when the May deliverable for West Texas Intermediate (WTI), which is the benchmark for the price of oil in the US, crashed to as low as minus US$40 per barrel.

The crash in the US oil futures spot market is not only a grim indication of what is to happen to oil prices in the next few months. It tears away the aura of invincibility that oil has always held in the commodity world.

Known as the ‘black gold’, the view has always been that demand would never fade away for oil and hence the possibility of the futures market going to negative levels is unthinkable.

But the notion of oil being a safe bet for trading purposes obliterated when the May deliverable for West Texas Intermediate (WTI), which is the benchmark for the price of oil in the US, crashed to as low as minus US$40 per barrel.

This means that the trader holding the option to take delivery of the oil in end May paid the counter party as much as US$40 to rescind on the contract.

The crash in the May futures of WTI has caused some oil-based exchange traded fund (ETFs) to take a severe hit.

There would be many more casualties such as Singapore’s Hin Leong Trading Pte Ltd folding up, happening in the next few months.

The crash on Monday happened due to two reasons. Firstly, there was an over-supply of oil exacerbated by demand falling fast due to the lockdown of the global economy.

The Covid-19 pandemic is still spreading and nobody has any idea when economic activity will come back to normalcy.

Secondly, analysts believe that lack of storage space in WTI’s contract delivery point at Cushing Oklahoma sparked off panic among traders.

They realised that with the contract due to end soon, there is nowhere to store the oil. The tanks at Cushing store about 72% of the working storage capacity requirement of the US.

There are other places to store oil but most would have been taken up by traders holding long term leases. These traders with long term storage spaces would have made a killing from the collapse of the futures contracts on Monday.

To shore up prices, the US government is looking at opening up emergency storage sites it owns for oil producers to store oil.

This move is expected to bring some relieve to the market prices of WTI. But it is highly unlikely to save the numerous shale oil and gas operators who cannot afford to produce if WTI persistently stays at US$20 per barrel levels.

The price of Brent crude, which is more related to Malaysia, is also beginning to feel the effect from the collapse in the price of WTI futures.

The spot prices also fell to about US$21 per barrel from US$27 per barrel at the time of writing.

The collapse of the futures markets to negative territory has never happened before in the history of the oil market.

But then, the world is also going through an unprecedented challenge in containing a pandemic.

Malaysia’s budget that was unveiled in October last year was based on Brent crude at US$62 per barrel.

In its latest assessment, the government is looking at Brent crude to average between US$25 to US$35. Malaysia may be able to see some respite towards the second half.

But it can only happen if global supply reduces.

The collapse in oil prices came only a week after Opec and Russia sealed a deal, which was trumpeted by US President Donald Trump as a landmark agreement to stabilise oil prices. But the stabilisation did not happen.

The only way for prices to go up or stabilise is if one or all three factors happen -- producers shut down their taps, more storage space springs up or demand picks up.

The probability of more storage space coming into the market is remote.

Dialog Bhd’s storage capacities in Pengerang and Tanjung Langsat in Johor are already full.

As for demand, there is no way anybody can predict with certainty when the economic lockdown will be lifted.

The only thing left is for producers to shut down their taps.

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