U.S. Oil Market Crash and Subsequent Slow Recovery – an Overview
The COVID-19 pandemic and the oil price war at the outset of 2020 have worked together to drive oil prices to record lows this April 2020. Oil markets are extremely volatile, with investors hesitant to invest in the oil and gas sector. With fewer consumers burning oil amid the Coronavirus pandemic, and required lock-downs, there is little demand for oil, and subsequently oil prices have fallen more than 70%. Early this week, on Monday, oil prices saw a devastating drop, including never seen in our lifetime drops of the front month future into negative territory. This occurrence was due to the lack of storage capacity, price of storage combined with the immediate need or lack of need in this case. The front month May contract for West Texas Intermediate (West Texas Intermediate (WTI), the benchmark for US oil prices) crude which expired on Tuesday couldn’t be given away, and actually people were being paid to take delivery of oil. This led to a market where the market was paying buyers as much as $38 per barrel to take delivery of oil in May. The buyers get the oil but must take delivery and store the oil, at a time of diminishing need.
This unprecedented event triggered a sharp fall in stocks. DOW experienced a decline of more than 1,000 points (5.1%) between Monday and Tuesday. The S&P 500 and Nasdaq followed suit, losing more than 4% each to start off the week. Interestingly, Oil company shares did not fall with the May contract reinforcing the notion this was a short term disjoint, and due to an extreme oversupply. The Energy Select Sector SPDR Fund that holds oil giants such as Chevron, Exxon Mobil and ConocoPhillips, was down by just 3%., but many bulls feel the oversupply story is built into the oil stocks recent devastation at this point.
Can this drop be temporary?
However, as Pippa Stevens of cnbc.com pointed out early this week, the situation may not be as bleak as projected. She drew attention to the fact that the West Texas Intermediate crude contract that fell more than 100% is for May delivery and it expired on Tuesday. With the loss of demand caused by the COVID -19 pandemic and oil still being produced, this front month oil contract that was about to expire had no demand. That’s the reason for the negative scenario with producers having to pay buyers. Futures contracts trade by the month, and the contract for June delivery was down but not trading negative. June was 16% lower at $21.04 per barrel. Therefore, after the May contract expires on Tuesday, she said oil could be back above $20.
According to John Kilduff of Again Capital, the steep decline in the May contract could be because “the physical oil market conditions are a disaster, with growing concerns about finding available storage.” He says the picture looks brighter for the longer term. He saidto CNBC, “The higher priced, longer-dated futures contracts are indicative of the market expecting some level of clearing in the cash market over the course of the next several months.” He added that given the rapid decline in the U.S. oil rig count and the expected cutback by OPEC+ members that is a reasonable assumption (Source: cnbc.com).
Positive Vibes on Wednesday, April 22
The clouds lifted on Wednesday, April 22 with the stocks rising for the first time in three days as crude prices stabilized after the record plummeting on Monday. We can see oil stabilized and the bulls had their way with a big day and turnaround in sentiment.
The Dow Jones Industrial Average rose 456.94 points (nearly 2%) to 23,475.82
The S&P 500 also rose by 2.3% to 2,799.31
The Nasdaq Composite advanced 2.8% to 8,495.38
The West Texas Intermediate contract for June had one of its strongest rallies in memory and advanced 19% and settled at $13.78 per barrel. Brent Futures were up 7.6% at $20.37 per barrel after recovering from a sharp overnight drop.
Alongside oil’s advancement, energy stocks rose broadly with the sector gaining over 3%. Halliburton closed 10.3% higher; Noble Energy and Diamondback Energy both gained more than 7%. Plausible Reasons for the Oil Price Decline
As mentioned at the outset, the huge decline in demand for oil is the major reason for the fall in oil prices. The U.S. Energy Information Administration informs that in the past four weeks, U.S. gasoline shipments have declined more than 30%, and jet fuel shipments have fallen 40%. Market observers say that individual investors pouring capital into the United States Oil Fund (NYSEMKT:USO) may have had a major role to play in Monday’s crash. Bloomberg reports that perhaps 25% of outstanding May 2020 futures were held by that fund on Monday and this is something that could happen when investors who cannot actually take the oil are trapped in a huge imbalance between supply and demand.
Slow Recovery Expected as the Economy Reopens
Oil demand is expected to rise, though slowly, as the economy reopens after COVID-19. The major concern is that oil inventories and supplies of refined products could stay at highest levels because producers have been very slow to respond by cutting down production. More imported oil is expected to reach U.S. markets soon.
Jason Hall (in The Motley Fool) says that investors must tread lightly in view of the low oil prices that are creating massive problems for the entire oil industry value chain at present. Apart from a few prominent and best-capitalized companies such as Royal Dutch Shell (NYSE:RDS.B) (NYSE:RDS.A), and Phillips 66 (NYSE:PSX), much of the oil industry is “un-investible” right now. It could take quite a while for the oil industry to be back on its feet because even post COVID-19 when the economy recovers slowly, there will be hundreds of millions of barrels of oil to reckon with before oil production can start recovering.
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