How do you fight an enemy that you can’t see, feel, hear, smell or touch? One that has infected more than 325,000 individuals and sent the global economy into a tailspin. The answer, according to the world’s major central banks, is to throw everything at it including the kitchen sink. Last week they announced an unprecedented offensive to mitigate the financial fallout from the coronavirus pandemic. The multi-trillion dollar packages included a flurry of new QE programmes and emergency rates cuts. These liquidity measures were backed up with a barrage of fiscal stimulus. Yet while these shock and awe tactics provided some initial support, they ultimately failed to conclusively assuage fears of a virus-induced recession. If anything, these measures simply contributed to an intense bout of volatility.
Indeed, volatility gauges on Wall Street hit an all-time high last week. The Dow Jones suffered its biggest one-day rout in history only to subsequently post one of its biggest rebounds on record. Yet for all these price swings, the index was left nursing a hefty 17% drop for the week, its worst showing since the 2008 financial crisis. All the while, volatility levels were even more pronounced in the oil market. Prices fell to levels not seen in nearly two decades as double-percentage moves became the norm. WTI plunged 29% over the week to finish at $22.53/bbl, the steepest drop since 1991. Brent declined by 21% to settle at $26.68/bbl.
This intensifying bearish malaise came as market players fretted over the twin shocks of surging supply and demand destruction. On the supply front, Saudi Arabia made good on its promise to flood the world with oil after Russia pulled the plug on OPEC+. The kingdom said it would lift supply to a record high of 12.3 mbpd in the coming months. Sensing the danger posed to US oil producers, Donald Trump hinted he would intervene in the Saudi-Russia price war. Russia, however, is unlikely to blink. The Kremlin responded by saying no one should interfere with its relations with Gulf producers. In short, it won’t submit to any pressure from Washington and the oil price war will continue.
Meanwhile, global oil consumption is retreating with increasing vigour as countries go into lockdown in response to the spreading Covid-19 pandemic. The end result is that the oil market is staring down the barrel of what may be the most extreme global surplus ever recorded. World oil inventories could swell by a colossal 1 billion bbls in the first half of 2020, according to IHS Markit. Set against this dismal outlook, the downward spiral in oil prices is poised to continue and may well reach the mid-teens. Put simply, the search for a price floor is by no means over.
Trouble ahead for US crude exports
We’re all familiar with the narrative regarding US crude exports. Shipments have surged since the lifting of a ban in 2015, so much so that the US now exports crude oil to more destinations than it imports from. Latest EIA monthly figures show US crude shipments hit a record 3.69 mbpd in December. This unrelenting ascent continued at the start of this year with exports reaching 4.38 mbpd in the week to March 13, the second highest weekly level on record. The upshot of this intensifying trend is that the US was a net exporter of crude and refined products over the past five weeks, the longest streak on record.
As much as the US appears well placed to become a net petroleum exporter on a sustained basis, a change of pace is now on the cards. The coming flood of Saudi crude and virus-induced plunge in oil demand has created a perfect storm for the US crude export machine. For starters, freight rates have skyrocketed on the back of a Saudi-led bookings bonanza. Vessels are in high demand from the kingdom as it strives towards boosting its crude exports. At the same time, oil companies are rushing to secure tankers for storage purposes. Global inventories are swelling, and onshore storage facilities are in danger of reaching their tank tops within months. The rush to secure additional storage has therefore shifted to offshore vessels. This has compounded the uptick in soaring rates which, in turn, risks undermining crude flows along the US-Asia export route.
Alongside increased shipping rates, US crude shipments are at the mercy of tumbling product margins. Refining profits have plunged as the coronavirus pandemic depresses demand for transportation fuels such as gasoline and kerosene. The situation is particularly acute in Asia where refining margins have declined sharply amid the widening Covid-19 crackdown. For instance, Asian jet fuel margins posted their biggest weekly decline in over a decade last week. In short, the sharp drop in margins will erode Asian refiners’ appetite for foreign crude, much to the chagrin of US exporters.
Another hurdle facing the growth outlook for US shipments regards worsening arbitrage economics. US crude supply dynamics are currently displaying bearish signals. Domestic crude inventories are on the upswing as refinery throughputs take a breather. Stocks have risen in the past eight weeks by a combined 25 million bbls to an eight-month high of 453 million bbls. All the while, production is running at a record 13.1 mbpd. Even so, the US crude marker has recently narrowed the pricing gap with its global peers. In other words, it is strengthening relative to other crude benchmarks. WTI’s discount to Brent virtually disappeared earlier this month as it came to within 15 cts of trading at parity to Brent. Such a level has not been seen since 2016. More recently, the arb has stabilised around $4/bbl compared to $6/bbl in January.
The narrowing WTI/Brent spread spells bad news for US exporters. Specifically, it risks removing the economic carrot for Asian refiners to boost their purchase of US crude. Deteriorating arbitrage economics is just one of several headwinds facing US crude export prospects. Ultimately, American crude cannot compete with the incoming wave of discounted Saudi oil. Accordingly, early indications suggest that US crude shipments are set to plunge by about 1 mbpd in April and May. Not only will this be a blow to US producers but it may also jeopardize the country’s energy independence ambitions.