PETALING JAYA: The slump in crude oil prices has set the stage for a brutal and rapid destruction of supply, as production in the United States has fallen by almost a million barrels per day (bpd) or nearly 7% in just one month, from mid-March to mid-April and the contraction is likely to accelerate, according to CGS-CIMB.
It pointed out the last time US oil production went into sustained negative growth was from April 2015 to September 2016 when daily production contracted by 6%. The price of West Texas Intermediate (WTI) crude bottomed out in February 2016 and subsequently rallied for 20 months, rising from US$26/barrel to US$76/barrel.
“In a similar manner, the contraction in US production that just started could pave the way for the market to go into deficit within a few months, allowing the price of crude oil and the stock prices of oil majors to rebound,” said the research house in a report.
It noted that on April 20, May delivery crude oil futures contract fell into negative territory with a low of -US$40.32/barrel before closing at US$37.63/barrel, a first in oil market history. This was the result of the sudden shutdown of demand caused by the Covid-19 pandemic and the filling up of storage facilities in the US.
CGS CIMB said the storage problem is expected to persist until production is further reduced.
“The production cuts announced recently by Opec+ are insufficient to end the supply glut. The inadequacy of the move will maintain extreme financial pressure on US shale producers. This may have been the intention of Opec+ – to take away market share from US shale. As it is, US oil production has started declining,” it said.
Production cuts will likely also come from other countries. The International Energy Agency (IEA) estimates total non-Opec output cuts to reduce supply by a further 5.2 million bpd.
“Governments stockpiling oil in strategic reserves will withdraw some supply too. The IEA expects the oil market to move into deficit by the second half of 2020, while the Energy Information Administration is assuming that April will mark the bottoming of demand, with WTI crude recovering to US$31/bbl by end-2020,” it said.
Meanwhile, OCBC Treasury Research economist Howie Lee reasoned that last week’s oil price fiasco was caused by mismanagement by the US Oil Fund (USO), and a lack of storage space at the Cushing hub, but it is unlikely to happen again in the short term.
“In the past week, two key reforms stand out: The USO is now, in essence, a closed-end fund, and it no longer holds just front-month contracts, but has now spread its holdings up to 12 months ahead.
“In short, the changes made to the USO mean the selling pressures from having to roll over massive open front-month positions are now very much reduced. The negative-price pressure on the June contract from the USO will thus be much weaker compared to May’s,” he said.
As for the storage problem, it is highly unlikely that buyers will attempt to put themselves in such compromise again, and they may attempt to roll over any existing open longs earlier.
However, Lee said the mood remains highly bearish and uncertain, with no clear indication on when demand may return.
He highlighted that storage is set to run out by the end of the second quarter this year and few distillates are earning positive margins, if at all.
“While we expect prices to remain depressed, we do not see the economic justification for a benchmark crude oil to be trading at negative prices,” said Lee.
