https://www.cwbwealth.com/en/news-and-stories/insights/oil-dressed-up-with-no-where-to-go
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Oil goes negative
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Storage fills up
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Oil prices to remain pressured at least through to year-end
The stock and bond markets made a remarkable recovery in the month of April. Key stock market indexes in the U.S. and Canada were up more than 10% (CAD), while Canadian bonds were up over 3%. Although returns are still negative for the year, April has demonstrated the value in sticking to long-term plans, regardless of the temporary market environment.
Although the threat of a global pandemic may have been expected by some, the COVID-19 outbreak proved that no country was fully prepared for this reality. Governments are responding by doing their best to straddle the line between public safety and economic output. For the most part, they have done a good job setting up the global economy for recovery.
The last two months have been extraordinary in the true sense of the word. Our daily lives have changed drastically, as we have all witnessed things we did not think probable or even possible. For instance, the term “social distancing” was virtually unheard of until only a couple of months ago, and now, we live with it every day. Government mandated lockdown of all but essential services, air travel falling by 90-95%, massive unemployment, and the cancelling of almost all major events are just a few examples of our bizarre new world. Yet, while bearing in mind these astonishing examples of change in recent months, perhaps nothing was more shocking than what has occurred in the oil market.
In the month of April, the most commonly quoted U.S. oil price (WTI) closed in negative territory – this means that for the first time ever in history, someone would pay you to take oil off their hands.
You may be wondering, how could this have possibly happened? Our simple answer is this: supply and demand. As the COVID-19 “shelter-in-place” orders took hold, people drove and flew less, therefore causing a huge drop off in demand for oil-based products such as gasoline and jet fuel. We have seen global demand for oil decrease only three times since 1985, with the latest being a fall of 1 million barrels a day in 2009 during the Great Recession. According to many estimates, we could see demand fall by 5 to 10 million barrels a day in 2020 due to COVID-19. The demand destruction has been rapid while the supply response has been too slow to keep pace – in fact, Russia and Saudi Arabia pumped more oil into the market as the world economy slowed down.
For most products, excess supply is not much of an issue. For instance, if a retailer stocks up on snow shovels and there is no snow, they cut the prices to entice people to buy for next winter. If that does not clear the product, they hold the remainder in inventory (either in the store or off-site) and try to sell it next year. The oil market is different. Oil cannot be stored just anywhere and there is only so much storage capacity. The rapid decline in demand means that we are seeing “tank tops”. Storage is getting full and what space is left is already contracted out.
The price of oil that is quoted is usually a “futures contract”, which is a promise to take physical delivery of a barrel at a certain price on a certain date. In April, the May futures contract went negative. If you were to buy that contract, you would have to take possession of the oil in a month’s time. If you were not in a position to take physical possession, you literally had to pay someone to take the contract off your hands. So what does this mean for the future of oil? Today we are seeing companies in North America and OPEC countries cut back on production and try to balance the market. As global economies reopen we will see demand start to rise. At first, any increase in demand will be easily offset by the supply in inventory. Eventually, as inventory works down, production will increase and we will likely see prices rise. How fast and high depends on how quickly we get back to normal and how quickly supply reacts. In the interim, we are likely in for low oil prices at least through the rest of 2020.