Falling gasoline prices usually stimulate demand – unless, as it is the case now, weak prices are the product of a temporarily irreversible fall in demand. The NYMEX RBOB contract is a good barometer of what the US is currently facing. It fell 32% yesterday as the spreading coronavirus is expected to severely dent domestic demand. It has lost nearly 80% of its value over two months and it is now cheaper than WTI. Despite yesterday’s shocking performance the other contracts managed to gain and the optimism prevails this morning. The US crude oil benchmark strengthened 73 cents/bbl and is up another $1.30/bbl at the time of writing. Front-month Brent only edged up by 5 cents/bbl but has jumped another dollar overnight.
This positive performance is down to expectations. Although the proposed $2trillion economic stimulus measure failed to advance in the US Senate yesterday and therefore stock markets fell it is widely anticipated to pass soon. On top of that the US energy secretary told Bloomberg TV yesterday that a potential alliance between his country and Saudi Arabia is one possible way to stabilize the oil market. It is, of course, million miles away from being a forgone conclusion nevertheless with the possible unlimited dollar funding it was enough to trigger a relief rally. The prolonged impact is questionable. Not only the RBOB contract keeps falling out of bed but the structure of the two main crude oil futures contracts also keeps weakening. Front-month WTI fell 39 cents/bbl yesterday and Brent 24 cents/bbl. The world is widely expected to be awash with oil in the foreseeable future.
There is ample US stock capacity
The oil market and prices are currently under immense pressure from both demand and supply sides. There are numerous forecasts and estimates that expect a significant fall in global oil demand due to the coronavirus. The extent of this destruction cannot be known at this point. The supply side of the equation is almost equally as uncertain as demand. Only almost because the market is currently working on the basis that Saudi Arabia is increasing output by 2.5 mbpd in April and May and Russia will also likely to up its production and exports by a few hundred thousand barrels per day. The immediate fall in production from high cost producers will be negligible, it will only come to the forefront of analysis in a few months’ time.
So the impact of the current epidemic on global oil demand is uncertain but negative and we know that global oil supply will rise significantly in the next two months, at least. This will create a market flooded with oil. Projections put the global oil balance for next month anywhere between 6mbpd and 10 mbpd. This is already pushing oil prices lower and is considerably weakening the structures of the two main crude oil futures contracts as mentioned above.
The question is how the market copes with the abundant quantity of oil on offer. Trading houses and integrated oil companies are trying to take advantage of the current structure and they rush to secure storage space including oil tankers. As a result, freight rates are going higher. When storage and/or takeaway capacity disappears oil prices will fall further, possibly to the low teens, and the contango will widen even more. It would not be unprecedent to see certain grades offered at a negative price. The West Canadian Select grade has already broken below the $10/bbl level last Wednesday.
Whether the above surreal scenario becomes reality or not depends on the available global storage. Data on spare capacity is not readily available therefore one can only turn to the next best thing, US storage reports. The EIA provides us with a reliable weekly update on US oil inventories and they also release a storage capacity report twice a year. The last one was published last November and covered the period up to September 2019.
It showed that total commercial working storage capacity stood at around 2.172 billion bbls at the end of September. The breakdown is as follows: refiners had storage space of just below 600 million bbls, bulk terminals 1.062 billion bbls and crude oil tank farms (excluding pipeline fills) 510 million bbls. US commercial stocks stood at 1.263 billion bbls last week. This implies a spare capacity of 900 million bbls or 42% (provided no extra storage has been built since September 2019). If you add to that a spare capacity of around 80 million bbls in SPR you might conclude the situation is not so dire.
The picture is more or less the same on the crude oil front. According to the latest report the US has a total working crude oil storage capacity (including stocks in transit) of 777 million bbls. Last week’s report put commercial crude oil stocks at 454 million. This is a utilization rate of 58%. Crude oil inventories at Cushing, Oklahoma can store 78 million bbls of crude oil, last week inventories were below 39 million bbls or 50%. As a comparison, the utilization rate at Cushing was 87% in 1Q 2011and the front-month spread WTI spread was $4/bbl in contango. The increase in Saudi production will surely have an impact on US crude oil exports and imports. Inventories are likely to rise and consequently the structure could weaken further. It is, however, unlikely that, given the level of current spare capacity, US commercial stocks and within that crude oil inventories will overflow in the foreseeable future.
It is not possible to predict the end of the current pandemic. When it comes, however, risky assets will rally. There is no reliable “coronavirus indicator” that could forecast when the tide turns – as far as containment and economic sentiment are concerned. Below, however, you will find an attempt to provide a feel for it. From now on every day we plan to publish a table at the bottom of this report. This table contains two pieces of information: the reported cases of the coronavirus in different parts of the world and the changes from the previous day and from March 16 when we started our records. Secondly, it will show stock market changes as well as the movement of the dollar index. The starting date in this category is January 23 when markets, in general, started to react to the epidemic. The former is a good reflection what investors think about central bank and government efforts in taming the economic impact of the virus. The latter implies the appetite for the dollar. As the lion’s share of the world’s trade is executed in dollar in times of panic the rush for the most important reserve currency intensifies as financial obligations occur in dollars. Hence the recent sell-off in risky and safe assets last week. In other words, a strong dollar index implies severe concerns and vice versa.