Central banks all over the world have launched massive stimulus packages and cut interest rates. These are the most obvious steps economic policy makers can take under these unprecedented circumstances, but they do not work. It appears that market moving events usually occur over the weekend and the latest round of emergency rate cuts and the launch of the massive $700 billion bond buying programme have failed boost investors’ morale. Investors rightly conclude that when the average person stops spending, travelling, sending his children to school but is forced to put unbearable strain on the health system no amount of monetary or fiscal stimulus would work. Worse yet, central banks are using up their ammunition and it is anyone’s guess how they could support the economy when the spread of the pandemic is finally contained. Despite firing from all cylinders stock markets took another steep dive yesterday. US equities dived 12%. The impression is that the sentiment in the financial market will only start improving when confirmed cases are dropping. From this respect it is probably more important to follow developments about the fight against the virus than financial data. The website ncov2019.live provides up-to-date information about the pandemic. Asian stock markets and US index futures are regaining some of the lost ground but this is more of some bottom-picking than a change in the underlying sentiment.
Oil has made new lows. Brent found itself below the $30/bbl mark for the first time since February 2016. From the technical perspective the bottom from January 2016 at 27.10 is now a very valid downside objective. (The same figure on WTI is $26.05/bbl.) A break and close below these supports will likely intensify the downtrend as black boxes and algorithms will give new sell-short signal. Whilst the two main crude oil futures contracts look anything but encouraging -especially Brent- RBOB is simply dreadful. It has closed below the 2016 low of 89.75 cents/gallon. As a comparison, May Brent has fallen 52% since January 21 and the April RBOB contract lost 62% of its value.
We mentioned in yesterday’s report that investment bank Goldman Sachs forecasts a stock build of 6 mbpd in April due to demand erosion and supply tsunami. IHS Markit did its bit yesterday to paint an equally downbeat picture. The key takeaways from its forecast are as follows:
- January-June stock build could be anywhere between 800 million 1.3 billion bbls. This is 4.4 mbpd-7.1 mbpd on average with 2Q presumably higher than 1Q. This would far exceed the six-month global surplus of 360 million bbls in 2015-2016. Our view is that the only silver lining of surging inventories and low prices is that it will provide some kind of support for the global economy when it wakes up from the current nightmare and starts its recovery.
- Low oil prices will have a negative impact on US oil production. It is estimated to fall by 2-5 mbpd over the next 18 months. We can only repeat ourselves from yesterday: the US benchmark could command a premium over the European crude markers in the not so distant future. The May arbitrage is currently -0.55 cents bbl but the September WTI/Brent spread looks very cheap if the effect of the virus lasts well into the second half of the year: it settled at -$3.82/bbl yesterday.
Demand destruction will be tangible earlier than April, maybe as soon as tonight and tomorrow when the API and the EIA release their statistics. As mentioned above, RBOB is the weakest component of the oil complex. Front-month RBOB settled almost at parity to WTI yesterday down from over $18/bbl two weeks ago. It would not be surprising to see sizable builds in gasoline stocks and significant fall in demand due to the spreading of the virus in the US. Nationwide crude oil stocks, especially in Cushing, should build, too. The Saudi-Russian output war forced US traders rush to secure storage space. This, in turn, could put further pressure on the WTI structure widening the contango.
At the end of January we pointed out that there are a number of indicators that will imply that the crisis is nearing to an end and the market confidence is rising. Apart from the obvious worldwide fall in confirmed cases these were chart analysis, volatility, demand for safe havens, structure and crack spread price movements. They are not showing any sign of reversal in fortune.
The long-term M/As are way above the price action. On the crude oil contracts the 200-day M/As are much higher than the current price level – almost $30/bbl. High volatility is usually translates into low prices. It is now above 100% with no let-off in sight. This does not suggest a trend reversal either. As far as safe havens are concerned, the safest of these, gold is intriguing. It ran above $1,700/ounce last Monday but has collapsed since. It closed slightly over $1,500/ounce yesterday despite a continuous sell-off in stocks and oil. One possible explanation is that investors are being forced to sell liquid assets to cover margin call in the equity markets. Treasuries, however, provide shelter. The yield on the 3-year US treasury has fallen from over 1.5% two months ago to 0.44% yesterday. Refining margins are dismal. On the cash basis some of them are already negative and the front-month 3-2-1 NYMEX crack closed below $16/bbl yesterday, a fall of more than 70% in less than two weeks.
As the Russian-Saudi stand-off and the fall in global demand has a more profound impact on Brent than on WTI the structure on the former is more severe. The front-month spread closed at -$1.64/bbl last night, down from +15 cents/bbl at the beginning of the month. The M1/M12 differential is now -11/bbl, a fall of $13/bbl from February 20. There is simply nothing, neither fundamental, nor technical development that implies that the rot we are currently experiencing would come to a halt any time soon. This will likely remain the case for weeks to come even though futures prices, led by RBOB, are correcting upwards this morning, possibly taking their cues from equities.