Oil fell on April 27 as traders are concerned with oil storage filling rapidly and fear that OPEC+ agreed production cuts will not enough to offset the demand plunge from the coronavirus crisis.
US WTI for June delivery fell 24.56%, or $4.16, to settle at $12.78 per barrel while international benchmark Brent crude fell 6.76% to settle at $19.99. Each contract is coming off its eighth week of losses in nine weeks.
Earlier in April, the Organization of Petroleum Exporting Countries (OPEC) and its allies agreed to a record production cut that will take 9.7 million barrels per day off the market beginning on May 1.
“Traders are extending the duration of their bets. Nobody expects a quick recovery in the oil price and it is now a case of playing it relatively safer with the longer duration contracts,” Chris Weafer, co-founder of Macro-Advisory in Moscow, told New Europe on April 28, adding that the contracts covering the next two months are effectively toxic, especially the WTI contracts.
“This is a sort of ‘chickens-coming-home-to-roost’ time for WTI,” he said, explaining that it is a very local US contract that was basically created by Wall Street traders to speculate on oil. It is based on the Cushing Storage facility and that worked very well while US oil production stayed in single figure millions of barrels per day. But as US oil production started to rise with the advent of shale technology, the contract has come under increasing pressure mainly because exports were restricted and Cushing was more often near capacity, Weafer said. Hence the WTI contract has traded at a discount to Brent for many years while, pre-shale, it traded at a premium.
Russia is set to reduce its western seaborne exports by half in May. Asked if this would this have an impact on oil prices, Weafer said Russia will not be able to comply with the full production cut, agreed as part of the OPEC+ deal, from May 1st. It will happen more gradually because of the technical issues with Russian oil production. “Volume output cannot be turned off, or on, as quickly as is the case in Saudi Arabia. So the reduction in Russian exports will be less than that agreed for some time. But if the reduction is moving in the right direction then this should not be such a big issue for oil traders,” he said.
According to Weafer, by far the bigger issues will be the demand trend, the scale of reduction in US shale and Saudi’s production volume.
In reality, nobody expected the OPEC+ deal to prevent Brent from falling below $20 per barrel in April. The hope for OPEC+ is that it remains intact to manage the oil market when the demand loss starts to ease and US production drops due to commercial forces, Weafer said, noting that if we get to mid-summer with the demand drop cut to, say, 10-15 million barrels per day and US production has dropped by 2-4 million barrels, then OPEC+ will be in a better position to manage the price of Brent back above $30. “But I would not expect the price of Brent to rise much above mid-$30s per barrel in the autumn as that would lead to a rebuild of US production and slow demand recovery. I believe OPEC+ will be more patient so as to keep US production recovery on a slow track,” Weafer said.
Ukraine offers oil storage
Ukraine, which has volumes of vacant oil storage facilities, said recently the country could take advantage of using them in the conditions of the oil prices turned negative. But Weafer said Ukraine won’t be able to take advantage of the shortage in oil storage capacity as its infrastructure is configured for oil transportation rather than storage. The technology in the pipeline system, including the storage units, are all designed to keep oil moving through the system and not to stay in the system for any length of time, he explained.
Ukraine’s system operator Ukrtransnafta has confirmed it cannot offer any storage capacity for oil traders both for technical and legal reasons, Weafer said, adding, “The relevant legislation only allows for the import and export of oil and does not allow the company to offer storage facilities, even if technically it could physically do so.”
