There are numerous estimates and forecasts released everyday by research departments and analysts that try to evaluate the impact of the global meltdown. Yesterday Bank of America expected 1H global oil demand to contract by 500,000 bpd. This contraction might spill over into the second half of the year. As oil stocks are building the investment bank anticipates a widening WTI contango, the arbitrage to turn positive and the outright price to fall below $20/bbl. The latter prediction almost proved accurate as the US benchmark bottomed out at $20.06/bbl. JP Morgan sees the US economy to contract 14% in 2Q and 1.5% in the whole of 2020.
Estimates are usually based on snapshots. As no-one knows the exact damage the current crisis will cause these projections are understandably revised on a constant basis. What is undeniable is that the world is melting down. Yesterday the US stock market sank another 6% although recovered impressively from the lows. Oil took a much more serious beating, especially WTI. It dived more than $6/bbl. Prices are so low that in percentage terms it is a fall of 24%. Brent fared much better as it “only” shed 13% of its value.
Such is the devastating impact of the COVID-19 pandemic that it is hard to make any sense of these prices. Daily changes are not indicative as they are driven by the hunt for cash. Investors currently demand cash at any price. This is why they are getting rid of everything, oil, equities, gold and treasuries – risky or safe assets, it does not matter. It simply cannot be known whether the price of an asset at any given time is fair or not.
Central banks are doing the best they can, but it is clearly insufficient. Yesterday’s stock market fall came despite the US administration asked the Congress to approve $500 billion in cash payment for taxpayers and $50 billion for airlines. It did not do the trick. Overnight the ECB, the BOJ and the RBA all introduced stimulus measures with questionable impact.
As prices are dropping, we are being asked more frequently where we think the bottom would be. It is probably the wrong question to ask. It should be re-phrased to “when the bottom will be reached”. As financial and monetary stimulus has not taken the desired effect one indicator that could be used in search for the bottom is the slowdown in confirmed cases and death toll in different regions. From this respect the picture is not encouraging just yet. Confirmed cases have risen 35,000 globally in the past two days, one-tenth of it in the US and 25,000 in all of Europe. It appears that currently the US is a major source of concern for a number of reasons. Firstly, the virus is not as widespread as in other parts of the world implying that the worst is yet to come – as of yesterday there have been less than 8,000 reported cases compared to 36,000 in Europe. Secondly, the US has a relatively low number of hospital beds and doctors per 1,000 persons. Thirdly, the number of uninsured Americans is very high. As the virus spreads all over the country economic fears will also grow. The coronavirus can easily cause a much severe economic damage than the 2008 financial crisis. The S&P 500 index turned at 670 back then, it is 2,400 today. Unless there is tangible reduction in reported cases or at least the growth rate slows considerably every rally in risky assets will prove to be short-lived.
The investing fraternity is so preoccupied with raising cash that a bullish weekly EIA stock report failed to have a meaningful impact on oil prices. Total commercial stocks fell for the seventh consecutive week as crude oil inventories built by only 2 million bbls, but gasoline and distillate stocks drew by 6.2 and 2.9 million bbls respectively. It is the coronavirus and only the coronavirus that matters.
Supply shortage in the making
The current health crisis has triggered both supply and demand shocks. It is impossible to predict how global oil demand will be affected because no-one knows how long it will take to bring the pandemic under control. As the situation currently stands demand recovery is not anticipated until 3Q at best but the impact of the pandemic might well be felt well into 2021.
On the supply side the shock came in the form of a price or market share war between Russia and Saudi Arabia. Its impact is there for everyone to see. Brent has fallen from $66/bbl to $25/bbl in the space of less than two months as the deadly cocktail of demand destruction and supply surplus is taking its toll. Amongst the casualties are US shale companies. Even before COVID-19 struck they had been under immense pressure from investors who had demanded to see return on their investment. It is no coincidence that the EIA, which saw US oil production grow 1.26 mbpd in 2019 cut its estimate to 1.06 mbd for this year and 410,000 bpd for 2021 two months ago. These forecasts were revised further downwards this month to 760,000 bpd for 2020 whilst next year now shows a contraction of 330,000, according to the EIA’s Short-Term Energy Outlook released last week.
The unbearable pressure US shale companies are is laid bare in the fall in their share prices. Between the last financial crisis and the end of 2019 shares in one of the most prominent US shale producers, EOG Resources rose 158%. In these 12 years the S&P Global Oil Index returned only 96% to investors. (On a side note the US equity market outperformed both as the S&P 500 index jumped 330% between November 2008 and December 2019.) Anyway, fast forward 10 years and picture could not be different. In 2019 EOG shares closed almost 4% down whilst the oil index gained 15% with the S&P 500 Index strengthening 29%. Year-to-date (up to March 17) the shale company has lost another 73% of its value (it has fallen from above $80 to $30). The oil share index is down 52.5% and the S&P 500 index has lost 22%. Long forgotten are the days when the Trump administration criticized OPEC for manipulating the oil market by reducing production. In fact, US senators are now calling on Saudi Arabia and Russia to stop the price war and are pursuing the president to impose oil embargo on the warring countries.
Lack of investment, spending cuts will lead to a significant fall in US production this year and probably an even bigger reduction in output in 2021. Some Permian producers are cutting budget by as much as 25%. Goldman Sachs believes that these companies are preparing themselves for a prolonged period of $30-$35/bbl price level and the bank envisages a fall of 1 mbpd in US production by 3Q 2021. Energy Intelligence predicts an “irreversible collateral damage to the US shale industry”. They also forecast that global upstream spending this year will fall below the 2016 level and some $500 billion in annual investment is needed in the medium term to avoid supply shortage. In other words, the combination of demand Armageddon coupled with supply tsunami has sowed the seed of supply deficit in years to come. Until then, the current prices will inflict severe pain on high cost oil producers and quite a few of them will go bankrupt.