Oil: lower for longer is the new normal in the midst of a declining global economy

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Russian President Vladimir Putin.
Russian President Vladimir Putin attends meeting on the state of world energy markets via … [+] teleconference at Novo-Ogaryovo state residence outside Moscow, Russia, Friday, April 3, 2020. Vladimir Putin says he supports cutting oil production by about 10 million barrels a day to support the fall in oil prices.
Alexei Druzhinin, Sputnik, Kremlin Pool Photo via AP

Oil prices have managed to gain ground in recent trading sessions, but are still well below the starting point for the year. The oil market is on life support after being hit by both demand and supply shocks.

Since the COVID-19 epidemic emerged from China, the global oil market has experienced a massive demand shock that has seen the need for transportation fuels dramatically decrease as lockouts spread to Asia, the United -United and elsewhere.

COVID-19 decimated demand for oil by shutting down much of China’s economic activity, which had accounted for 35% of global GDP growth, and essentially abruptly cut global air traffic, reduced car traffic to ” 50% in many markets and economies around the world.

At the same time, Saudi Arabia and Russia engaged in a price war for market shares, which caused a major supply shock. The Organization of the Petroleum Exporting Countries, Russia and other producers, a group known as OPEC +, have reached an unprecedented deal to remove about 10% of the world’s supply, but that already seems too much little, too late.

Demand may have dropped by 30% and the world may be just a few weeks short of storage space for all the excess oil. Producers literally pay traders to take the goods away from them as oil prices get negative.

In a physical commodity market, oversupply will always trump sound clips and statements from government officials seeking to drive up prices. Conversation is cheap in a physical market like oil.

The storage tanks are full, everything is full, there is no place to put the oil, which has led to this ridiculous situation where the price of something that is necessary for our way of life has actually become no.

For the first time in its history, OIL for delivery finds its clearing price at ZERO. The price went negative this week, signaling that there is no place to store all the crude that the world produces and does not use.

This is an oil crisis like no other, and as things get worse, the disreputable side of geopolitics is likely to emerge, as the recent conflict between (MBS) Mohammad bin Salman Al made clear. Saud, Crown Prince of Saudi Arabia and Russian President Vladimir Putin.

Saudi Crown Prince Mohammed bin Salman

Saudi Crown Prince Mohammed bin Salman attends meeting with US Secretary of State … [+] in Jeddah, Saudi Arabia, on September 18, 2019.


MANDEL NGAN / AFP via Getty Images

More than other countries, Russia is facing the shock of world oil prices due to its strong position, but the test will be domestic confidence in the macroeconomic framework in place since 2014.

According to the United States Energy Information Administration database, Russia is the world’s third largest oil producer, surpassed only by the United States and Saudi Arabia. According to Moody’s, the most vulnerable oil producers in terms of credit profiles are led by Oman and Bahrain, members of the Gulf Cooperation Council (GCC).

World oil demand will plunge to a record 9.3 million barrels a day in 2020, wiping out a decade of growth in consumption, aaccording to the IEA (International Energy Agency).

The IMF said the global economy is expected to shrink 3% this year. The economies of Asia’s main trading partners are expected to contract sharply: the United States should contract by 5.9%, while the euro area as a whole should contract by 7.5%.

China is one of the few economies poised to grow in 2020, according to the fund’s projections. But the IMF’s 1.2% growth forecast for the country is a sharp slowdown from China’s economic performance in previous years.

Regardless of other OPEC + stocks, the world is headed for an extremely oversupplied market and a period of sharp drops in oil prices. The speed with which oil prices recover is largely dependent on the trajectory of the virus and the mitigation measures necessary to contain it.

The current unprecedented shock to oil demand and the resulting collapse in prices could ultimately create a large negative shock to oil supply and a rapid rise in prices. The violent nature of this process will permanently change the global energy industry and its geopolitics, create inflationary pressures as economic activity normalizes post-coronavirus blockages and shifts the debate around climate change.

With the prospects for COVID-19 closures worldwide still uncertain, there is no clear end in sight for low oil prices. The big point to remember about the oil market is that there is a physical component to this market. Oil is not like the stock market, it is not a trusted market.

The price divergence between the two benchmarks of Brent and WTI (West Texas Intermediate), also known as Texas light sweet, is attributed to the storage dynamics.

Brent crude is sold in the middle of the North Sea, where tanker storage is large and accessible, while storage of WTI oil in the United States is limited and landlocked, making transportation relatively more difficult. As a result, Brent is further from the shock of demand for coronavirus and WTI prices are much more sensitive to this shock, as demand drops, storage fills and prices fall.

Negative oil prices like those reached for the first time in history on April 20 will force oil producers to leave it in the ground. Oil producers need more demand than supply for stocks to be drawn and prices to be discovered.

According to the International Energy Agency, the total cost of producing a barrel of oil, which includes the cost of research, the write-downs of the previous year, the cost of capital and social rents such as taxes, is between 50 and 60 dollars per barrel. The petroleum industry cannot continue to produce a product below its cost of capital, the petroleum industry will self-liquidate and, in fact, will self-liquidate.

In the final analysis, the remedy for low prices is low prices. In the meantime, however, the potential for a V-shaped recovery in energy demand is low, especially since we expect a larger L-shaped recovery in global stocks. Lower for longer is the new standard for petroleum.

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