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March
25
2020

Oil Prices Are Set To Plunge Again

Oil prices have been on the slide for more than two weeks now, and they will, in all likelihood, continue downward despite the respite from the United States legislators who raised hopes that they could agree on a $2-trillion economic stimulus package in response to the pandemic.  But will this be enough?

Reuters' John Kemp wrote in his latest column on hedge fund oil positions that global consumption of fuels had dropped by as much as 10 million bpd. He also said hedge funds had tried to feel the inflection point for oil prices twice since the crisis began and had failed both times. The final nail in the coffin of hopes: the economic situation, according to Kemp, is the worst since the Second World War.

What this means is that recovery will take a while and it may well be a long while. Governments in Europe, like Washington, are announcing recovery plans, and central banks are planning stimulus packages. Yet, it would be unrealistic to imagine that the economies forced to the brink of a complete shutdown will suddenly flourish from the government financially supporting those hardest hit by the crisis. Let's not forget, after all, that besides the slump in consumption driven by the outbreak, we also live in a world of oil oversupply driven by a lingering imbalance between supply and demand, and most recently by Saudi Arabia's plans to boost production substantially as a way to force Russia to rethink its position on deeper cuts.

In this context, some hedge funds got swayed by wishful thinking and the generally solid reasoning that prices have fallen so far they must begin to climb back up soon, as Kemp noted in his column. Generally solid reasoning, however, does not work 100 percent of the time, and, to be fair, a lot of the buying hedge funds were reducing their short positions, according to Kemp. The oil industry, meanwhile, is preparing for oil to slide further.

Shell, Total, Eni, Exxon, and Chevron have all announced plans to cut their budgets in response to the price situation. Now, it's one thing if independent E&Ps in the U.S. shale patch announce spending cuts. It's another thing if the supermajors start cutting. When the supermajors start cutting, the situation becomes alarming. The world's largest vertically integrated oil companies are invariably much more resilient to price shocks and recession than smaller players. If oil majors think the situation is critical enough to revise spending plans and suspending share buybacks, then it must be horrible.

Unfortunately, it could get even worse. The imbalance in demand and supply also concerns oil in storage, which, because of this imbalance, has been growing. According to OilX, there are about 750 million barrels stored on land and offshore. This inventory could increase to 1 billion barrels, according to analysts.

Meanwhile, the pandemic is still in full swing, with a second wave of new cases grips some Asian countries. China itself reported 78 new cases this week after several days with no new diagnoses. Most of these were "imported” and came from people returning from abroad. A second wave of the disease could cripple transport industries even more severely, further delaying the recovery. It will also deepen the oil market imbalance.

While "the anticipated lengthy absence of air traffic presents a significant obstacle in its own right," the expected ramp-up in supply will fill storage quickly and cause prices to plummet as physical demand continues to evaporate, AxiCorp's chief global market strategist Stephen Innes told Reuters.

If this happens, no amount of production cuts would help oil as the fundamentals once again trump hopes, plans, and speculation. Even an oil alliance between Saudi Arabia and the U.S. won't be able to do much when storage space fills up while demand continues gasping for air.

By Irina Slav for Oilprice.com

 

 

 

 

 

Irina is a writer for the U.S.-based Divergente LLC consulting firm with over a decade of experience writing on the oil and gas industry.

 

 

 

oilprice.com

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