OIL IN NEGATIVE
Yesterday, April 20th, the international oil market was shaken by an unprecedented decline in the WTI, reaching negative values of up to minus $36 per barrel, something that had never happened before.
The fundamental reason for this phenomenon is linked to the fact that traders left their contracts early in May because there was not enough demand or storage capacity for oil. As a result, futures contracts for May 20th fell to $6.40 abarrel today, Tuesday, April 21st.
Although the Brent, the price marker for the European market, also fell to values below $20 a barrel, the greatest impact of the collapse of oil prices was suffered by WTI, marked for North American oil, basically because there is no storage capacity in Cushing Oklahoma, the «hub» for storing North American oil, whose inventories are based on the price of WTI which is then traded on the NYMEX.
The failure of the last OPEC+ meeting on March 6th was a determining factor in the destabilization of the oil market, not only because it coincided with the abrupt collapse of consumption caused by restrictions on movement, transport, and industrial activity as a result of the COVID-19 pandemic, but also because this disagreement gave rise to a price war between Saudi Arabia and Russia.
While this price war between two of the three largest oil producers in the world flooded the market with cheap oil, the demand continued to fall, estimated at 20-30%, due to the paralysis of the world economy which went into recession. On April, both OPEC and the International Energy Agency predicted in their respective reports that the drop in demand for 2020 would be severe with a loss of between 6.8 and 9 million barrels a day in consumption, indicating that by April, the loss would be 20 million barrels per day.
That is why, as we said in our Oil Bulletin on April 17th, the production cut agreed by OPEC+, in addition to being late, would be insufficient in the face of the collapse in demand and the volumes of oil that have flooded the market, oil that has no one to consume it and no place to store it.
But, besides, this unprecedented cut by OPEC+ was an effort that was not accompanied by other large non-OPEC producers grouped in the G-20, such as the U.S. and Canada, which means that the different producing countries, especially the U.S., Canada, and, to a lesser extent, Mexico, preferred that «others» make the cut effort which deprived the oil market of a forceful and timely political decision that could have cut a volume of oil that could have been 15 million barrels of oil per day, and which would be subject to review by mid-year and for longer than just two months, as agreed in OPEC+.
While this imbalance in the market between supply and demand, and the uncertainty of the future of the world economy given the impact of COVID-19 continued to affect the price of oil, to this was added an element that seems to have taken by surprise or been underestimated by the market, which becomes a physical constraint, impossible to avoid: storage.
With an over-supplied market for oil and no demand, the commercial inventories of the OECD countries, China and India, began to fill up with cheap oil.
In some cases, such as China and India, or the strategic reserves of large consumers, this information is not reported to the market, but all analyses and reports, including the reports of the U.S. Energy Information Administration, EIA, indicated that oil inventories around the world were filling up at a very high rate.
Likewise, the increase of floating storage, that is, oil ships, was known both because of the impossibility of placing oil in the world refining system that has been decreasing or ceasing operations due to the lack of fuel consumption, as well as because of the expectation of traders or speculators who knew that the market was in «super contango» as defined by OPEC in its monthly report, that is, that the price of oil in the future was higher than the current one.
This is how the market was perceiving it, where even companies and countries like Mexico acquired coverage or «hedging,” negotiating financing for their future production until oil buyers realized that there was no longer space to store it, no matter how cheap it was, especially in the commercial warehouses in the U.S. and the Cushing’s in Oklahoma that reached their operational capacity limits, so they began to cancel their May contracts in advance so as not to have to pay for storage more than the value of the oil acquired. This is what caused the WTI to fall to negative values yesterday, April 20th.
Prospects for the short term.
Although future prices for May are in negative values, prices for June and July are being estimated for WTI of $15.55/barrel and $23.3/barrel respectively, and for Brent values for June and July of $20.46/barrel and $24.93/barrel.
This market expectation is based on the assumption of a massive reduction in oil production, either for economic reasons, political decisions by producers, or because of an increase in demand due to the progressive relaxation of restrictions on transport, travel, mobility, and industrial manufacturing, and commercial activities as a result of the gradual lifting of the COVID-19 quarantine in the industrialized economies.
How the three major oil producers, including the U.S., Russia, and Saudi Arabia, will act is unknown. A lot will depend on the relief from the price crisis.
North American production, including the U.S., Canada, and Mexico, is the most committed.
U.S. production of Shale Oil is unviable at these prices, even at prices between $20 and $30 a barrel. Hence, the efforts of President Trump’s Administration to seek an agreement in OPEC+, in addition to ordering the Department of Energy to open up the idle capacity of the country’s Strategic Reserves to buy up to 75 million barrels of American oil, store it, and then sell it when the price recovers.
For this to be effective in terms of volumes, more operations of this type will be needed, so the Trump Administration will need more resources from Congress, where it has already run into the Democratic refusal, who, because of environmentalist positions, are not willing to finance oil production in the country. The Administration, faced with the imminent drop in U.S. production, has already announced its willingness to impose tariffs on foreign oil imports, especially from Saudi Arabia.
Oil production from oil sands in Canada is also a high-cost production with transportation and market problems. The same goes for Mexico, which for years has suffered a drop in production, not only due to the depletion of the Cantarell field but also due to the costs of deepwater production in the Gulf.
Saudi Arabia and Russia have low production costs and more room for maneuver in the collapse of the oil market. In the case of Saudi Arabia, the country’s financial strengths, as well as its system of government, allow it to remain in a prolonged crisis. In the case of Russia, a more diversified and industrialized economy, where oil and gas account for nearly 40% of its revenues, it has the leadership and political bargaining power to maneuver through this crisis.
In this situation, however, some of these countries seem to be insisting on taking strategic advantages in the oil sector in a scenario of everyone against everyone else, in dispute for markets and for keeping their respective industries and oil companies safe, in the face of market collapse.
In the medium term, it will be necessary to see how much of the international oil sector, oil-producing companies, oil services companies, and producing countries will be left standing and will be able to resume their activities once the COVID-19 crisis is overcome and after the economy gradually recovers, oil demand is restored, and accumulated inventories are drained. Only after this, we will see prices like those of the beginning of this year (2020) again.
This unprecedented crisis takes the country into the weakest situation of its oil industry and of PDVSA in particular since its creation in 1976. PDVSA’s operational and financial capacities have collapsed as a result of poor management and bad decisions by the government.
The company, now militarized, has been hit and dismantled by successive government interventions, as well as the persecution, imprisonment, and displacement of its management and technical staff.
Its production has collapsed from 2015 to date, with a drop of 2.4 million oil production. To our date, according to OPEC’s latest report, the country only produces 660 MBD of oil. Additionally, due to contractual changes made by the government, production is in the hands of private partners, who operate 84% of Venezuela’s production, while PDVSA operates only 16%.
On the other hand, the Venezuelan refinery park is inoperative, so the company is not able to process Venezuelan crude, nor supply the national market with gasoline, diesel, gas and other fuels.
Since Venezuela is a heavy crude oil producer, our main segregation, Merey Crude, has as its reference price the Mexican Maya crude and this, in turn, is indexed to the U.S. WTI. This means that the negative prices of WTI have hit Maya crude (it was quoted yesterday at -2.7 dollars a barrel), so our type of crude, in turn, is quoted at a lower price, without taking into account that, even before the price collapse, Venezuelan crude was being sold at discounts of up to 30%.
These negative price values or below $10 a barrel for the WTI, make it unviable to produce oil in the country. Even more so when Venezuelan oil production is in the hands of private operators, such as Chevron, CNPC, Rosneft (which ceded its assets and participation in the country to a still unknown Russian company), Gazprombank and Venezuelan operators without experience or financial capacity.
With oil production in private hands, interests other than national ones take precedence. Due to the lack of control over oil operations in Venezuela, it is impossible to develop a proper strategy to deal with this crisis. The question is, are these private companies going to produce at a loss? That could only have been done by PDVSA, the national company.
On the other hand, without operational refineries, the country is unable to process its oil, even if it is only 660 MBD, which in other circumstances could be transformed into fuel.
The country has run out of storage in the Caribbean because of the international isolation of the government and our own fleet of tankers, some of large capacity, which could be used as floating storage, were lost or have been confiscated abroad for lack of payments or debts.
Onshore storage in the country is insufficient and already has capacity issues, not only because of maintenance and mechanical integrity problems but also because U.S. sanctions have imposed restrictions on the export of Venezuelan oil. This problem could have been solved if the Quevedo administration (president of PDVSA) had kept our tanker fleet operational.
Oil production in the country will end up collapsing due to the combined effect of the weakening and collapse of PDVSA, as well as oil market conditions and the fall in oil prices. This crisis is taking the national oil sector in the worst conditions to face it.
We will have to see the performance of the economy in a scenario without oil revenues, an economy that the government has sustained on an artifice, a fiction: the coin called “Petro”, which today, at the time of writing this Bulletin, has negative values.