Tonight we got news of additional fiscal stimulus measures taken by the US Federal Reserve in the form of another interest rate cut. Last Friday, the Trump administration announced that it would begin purchasing oil for the US Strategic Petroleum Reserves (SPR). We now find ourselves in an ever-changing situation as a result of the coronavirus.
The SPR announcement provided some lackluster lift to prices last Friday. Taken alone, however, it's a drop in the bucket without additional coordinated action from global producers. Tonight we define what's transpired over the last few weeks in oil markets so you have the facts on hand to add to as additional information becomes known.
SUPPLY ISSUES
OPEC
Implemented oil supply cuts of 1.2 million bpd in 2017
Increased output cuts to 1.7 million bpd at the December 2019 meeting expiring March 31, 2020
Failed to reach agreement for an additional 1.5 million bpd cut at the March 6, 2020 Ministerial meeting which effectively allows existing production cuts to expire at the end of March, 2020
Saudi Arabia slashed its crude oil prices and promised to ramp up oil output starting in April, 2020
Russia announced that it can raise its oil production by 200,000 bpd to 300,000 bpd in the short term, with a potential for up to a total increase of 500,000 bpd
United States
February 28, 2020: The US Department of Energy (DOE) announced a notice of sale of up to 12 million barrels of crude oil from the SPR.
March 11, 2020: The U.S. DOE announced it is suspending its recently announced sale of crude oil from the strategic petroleum reserve (SPR) “in light of the recent fluctuations in global oil markets”
March 13, 2020: President Trump announces in a speech that the US government will take advantage of low oil prices and buy "large quantities" of crude to fill the Strategic Petroleum Reserve
What are "large quantities'? Using data reported by the US Department of Energy in their 2017 Strategic Petroleum Reserve Annual Report, the US has an additional 79 MMbbl of storage capacity that could be used at a fill rate of 785,000 bpd.
Considering the US purchase of barrels as some form of 'supply cut' (i.e. .785 million bpd) via storage purchases, it doesn't come close to offsetting the 1.7 million barrels of OPEC supply cuts that will not expire at the end of March, let alone any additional production like that announced by Saudi Arabia and Russia.
So many things are unfortunate about all of this. In a perfect world, OPEC would have left their supply cuts intact with the US making up the request for increased supply cuts via a commitment to purchase the maximum daily operational volumes for the Strategic Petroleum Reserves. Instead, assuming a max fill rate of 785,000 bpd, the available SPR capacity of 79 million barrels will be reached in 100 days.
The most notable SPR purchases in recent history were those immediately following the events of September 11, 2001 when SPR inventory levels were sitting about 80 million barrels lower than where we are starting from today (red line below).
US Commercial inventory (pink line above) will no doubt be filled but this will be a function of storage incentives offered by the amount of contango along the curve in reaction to short-term demand loss.
MARKET REACTION
At the moment, there is still room for more oil in traditional on-shore storage facilities and therefore 1-month calendar spreads moved into contango to reflect traditional storage costs. This was a swift departure away from backwardation that was pricing in short-term supply risks. From here, if the market begins to anticipate that the limits of conventional storage will be tested, calendar spreads should move even lower (more negative) to reflect the cost of the next available storage space (such as a barges or ships) and so on. But, we are not there yet - storage is not at capacity. Therefore, we expect one months spreads to pause or find a bit of support here unless we get more data showing a faster than expected rate of storage builds.
One reason for the slight bounce in spreads last week was an underlying belief by the market that some sort of outside intervention might step in and solve short-term over-supply issues. Friday's SPR announcement may have initially been read as having the potential to make more of an impact than the actual numbers reviewed above suggest. Over the weekend however, the pace and duration of business closures increased which also increases the loss of demand. Since the US Federal Reserve announced on Sunday evening that they were slashing interest rates again, it seems oil markets are still left waiting for an equivalent 'stimulus' move by producers.
Zooming out a bit to include a broader look at spreads over time, we see how much lower they were during the supply glut years created by the exponential growth of production in the US Permian region prior to the export ban being lifted.
We point this out to highlight how long it can take the spread market to 'work off' a supply glut.
DEMAND ISSUES
Pessimistic outlooks for oil demand gained traction last week as the virus spread across the globe. Between flight cancellations, school closures and a general sheltering-in-place, the oil markets are expected to continue to suffer losses in demand. The IEA also released a downward revision to their annual demand growth by 365,000 bpd.
The question everyone is trying answer is how deep the losses will be and for how long will they last. Since we are mid-crisis, there is both a lack of concrete data points and a growth in uncertainty. There are so many moving parts it's difficult to pin down assumptions and forecasts. Rather than muddy the waters with more loose data points, we thought it might be beneficial to look back and remind ourselves of the impact previous events have had on demand.
Global Liquid Fuels Consumption
US Liquid Fuels Consumption
As expected, it was the global financial crisis that had the largest impact on demand. Its also no surprise that demand impacts are magnified in the US rather than the world since the US is the largest consumer of petroleum and petroleum products. With Chinese demand now growing faster than in the US and data out of China being less transparent than in the US, it's no wonder the coronavirus impacts are infinitely more difficult to assess.
The containment timeline of the virus is still so unclear, making the shape of the recovery curve increasingly difficult to judge. Additionally, there are risks related to any actions OPEC+ may take if oil prices continue to fall. In the mean time, inventories should grow and the bigger they get and the longer we go without a meaningful reduction in production the longer oil prices will remain under pressure.
Inventory Recap
Weekly Stats
The EIA inventory report for week ending March 6, 2020 reported a total inventory DRAW of (3.70) million barrels with Crude oil showing a significant build of 7.70 million barrels.
Year-to-date, this bring us to a Total Inventory BUILD of only 5.20 million barrels. Builds are expected to grow significantly going forward as demand remains under pressure.
As discussed earlier, US inventory levels including that held in the SPR indicate that there is available capacity which should get filled in the weeks ahead as demand continues to be under pressure. This includes up to 79 million barrels available in US SPR locations.
