FxWirePro: Intricacies Of Crude Oil Inventories And Hedging Strategies

Many commodities strategists estimate that with no other countries added to the lockdown list, 14% of global oil consumption could be wiped out in April. If the rest of the world were to institute a complete lockdown, this number could rise to around 23%, worth at least a $20/bbl hit to price. There is little doubt that the price war between Saudi Arabia and Russia has exacerbated the crash. Their actions alone are worth another $10/bbl bite off the price, resulting in a modal prediction of $10/bbl Brent oil price by May. A 23 mbd hit to demand would require 1.3 billion bbls of storage in 1H’20 alone, likely filling up the world’s spare storage capacity by the end of summer, if not earlier. It is then not inconceivable for crude oil prices to fall further, turning effective sales prices for some crude streams negative.

It is not clear that reducing supplies would durably alter the trajectory of oil prices in the short run, but were the triumvirate of OPEC, the US, and non-OPEC producers to remove 1 mbd each and OPEC promise to not increase supplies (i.e., total supply impact of 7 mbd), we would expect prices to firm to about $30/bbl, all things equal. Saudi Arabia could alternatively choose to stay the course.

Given limited storage capacity, markets will need to price the reality that production will eventually have to be reduced or even shuttered. Widespread US light tight oil shut-ins will not occur until WTI prices plunge below $10-15 per barrel, but modest impacts could be visible as soon as WTI falls below $20/bbl.

Hence, we advocated shorts in CME WTI futures contracts of far-month tenors with a view to arresting further dips, since further price dips are foreseen we would like to uphold the same strategy by rolling over these contracts for May month deliveries. Courtesy: JPM