by Ranjit Singh
MONDAY April 20 was an eventful day for oil markets as the futures for the commodity dipped into negative territory for the first time in history.
The Covid-19 pandemic had caused a sharp contraction in the global economy which resulted in the demand for oil being reduced by 29 million barrels a day. The situation was made worse by the feud between oil majors Saudi Arabia and Russia which could not reach an agreement on production quotas.
The OPEC+ has since reached a consensus on a production cut of 9.7 million barrels a day, much less than the decrease in demand, resulting in a huge surplus of oil on the market and no buyers.
The cheap oil has caused many importing nations to store large quantities of oil and storage capacity has run out as a result.Oil traders do not have enough capacity to store the oil and are paying buyers to take oil stocks from them..
A few oil producers, hoping to maintain their market share, have taken to storing their excess oil at sea, leasing tankers at high cost. Some of these tankers have been leased for as much as US$100,000 a day.
Futures contracts for West Texas Intermediate (WTI), which are contracts for oil to be delivered in a few months at today’s price, lost US$6 a barrel on Monday, fetching US$11.66, but ended the day at -US$37 as holders of futures contracts tried to dump their contracts before oil was actually delivered with nowhere to store it.
This state of affairs cannot be expected to last for long. Producers, in the short term, may accept prices below their variable cost as long as they are able to pay some of the costs they will incur even if oil production shuts down.
Stephen Innes, chief strategist at Axitrader, told FocusM that he does not expect the low oil prices to persist for long.
“Looking further out, the market and energy equities in particular do not expect oil to be in the US$20 price range for long, hence the relative resilience shown by oil majors. But similar to broader markets, if there isn’t a relatively sharp bounce back in consumption, then energy and markets, in general, may be in for some prolonged pain.
“It really boils back down to how quickly demand re-engages after lockdowns are lifted and travel restrictions are removed,” said Innes
As time passes, more and more rigs will stop operating (technically, a few will be kept operational in order to avoid being compromised) and a new balance between supply and demand will be established at prices that exceed the total average cost.
Meanwhile, Dr Afzanizam Abdul Rashid, chief economist at Bank Islam Bhd, told FocusM that the extreme low oil prices would affect Malaysia as a net exporter of oil. He said low oil prices were attributable to a supply glut and weak global demand.
“This situation resonates with the oversupply condition as well as the expected decline in oil demand globally. The International Energy Agency recently forecast that global oil demand would fall by 9.3 million barrels per day in 2020, the first drop since 2009.
“Last year, China accounted for more than 80% of global oil demand growth. So the 6.8% contraction in China’s GDP in the first three months of this year would translate into lower demand for oil,” he said.
In Malaysia’s case, “consumers are usually the main beneficiaries of lower oil prices but the movement control order (MCO) has resulted in limitations to human mobility. However, food delivery services should be able to enjoy good profit margins as their fuel cost has been reduced.
“As for the government, this would affect its petroleum-related revenue. Nonetheless, the share of petroleum revenue has declined from 41% in 2009 to around 20% now. Overall, the sharp decline in crude oil prices suggests challenging global economic prospects,” said Afzanizam.
Presently, while Malaysia has reduced its dependence on oil revenue petroleum tax and dividends from state oil company Petronas are still important contributors to its coffers. Persistent oil price weakness will witness its revenue base being eroded. – April 22, 2020
