Join our community of smart investors

Updated Market Outlook: Oil tumbles again, US futures weak

Oil's dramatic slide has undermined market confidence
April 21, 2020

Updated 11.15am: More than just a rollover issue? Oil markets are in turmoil again today as both Brent and WTI contracts come under severe pressure, with volatility extremely elevated.

Severe dislocation in the May contract is spilling over into future months with the benchmark June WTI contract tumbling 40 per cent or so to take an $11 handle at one point this morning. It’s rebounded very sharply back to $16.50. July remains firmer above $20. Whilst the May contract went absurdly low because traders had to avoid taking physical delivery at all costs, the forward contracts look too high when you consider how much demand destruction is out there. If this super contango market persists we may see further implosions like we saw yesterday as we approach settlement as traders are caught the wrong side of the expiry with nowhere to put it. 

We are also seeing spill-overs into Brent which is facing the challenges with the front month – which we roll this Friday – dipping under $20 before paring losses and rallying back to $22. We will watch this one carefully to see whether it too shows severe stress, however volumes in the Jun contract remain high, unlike the May WTI contract which had become very illiquid. Fewer constraints on storage and the fact Brent is a seaborne commodity will help and should mean it outperforms WTI in the coming months. 

We’ve talked at length about this already with regards to the fact storage constraints are not going away any time soon unless you get a pickup in demand, which is not forthcoming. I think also demand destruction is worse than the refiners thought it would be. We also note the reports of a large volume of Saudi oil making its way to the US, which were loaded and shipped prior to OPEC+ deal when the Saudis were flooding the market with cheap crude. 

Fundamentally there is still a massive supply-demand imbalance which will take time to work its way through. OPEC+ cuts won’t really help for at least a month. We need to see the US economy moving again for WTI to recover.  US producers don’t want to endure the cost of voluntary shut-ins, it’s just not that easy to turn taps off.

Equities are suffering the fallout from this oil implosion with European bourses -c2 per cent and the Dow set to open around 400 points lower and the S&P 500 likely to fall below 2800. I would worry about what impact this crude market stress will have on credit markets and banks in particular as these companies won’t be able to pay their debt. Remember US shale was facing a wall of debt this year through to 2022 that already threatened to blow a hole in the industry.

Whether we look at WTI or Brent, bulls will hope the rejection of the lows marks a bottom but the pressure appears relentless.

 

 

9am:  Oil tumult worries investors

 

Gyrations and anomalies in the crude oil market grabbed all the attention yesterday, Rightly so, as West Texas Intermediate (WTI) crude – the US benchmark – tumbled into negative territory for the first time ever. Prices plunged at one stage to -$40, before climbing back into positive territory. It was a staggering event.A few things need to be considered. First this only related to the May contract which was about to expire and had become very illiquid as major trading desks had given up on it several days prior. CME Group data indicated volume of 122k for May contract vs 780k for Jun. Two, the Jun contract remained much firmer, albeit it too was dragged lower towards $20.  

You need to bear in mind that Nymex WTI is a physical contract – if you hold it expiration you need to take delivery. Normally as you approach expiration of a futures contract, traders simply roll their positions over to the next month without any fuss. What we saw yesterday was very much a roll over problem – traders holding the May contract couldn’t find any buyers because no one with the ability to take delivery wanted it. This is because of the collapse in physical demand for crude products like petrol and jet fuel, which means the storage capacity at hubs like Cushing, Oklahoma is near to ‘tank tops’. So, what we got was a severe dislocation as paper traders found they had to offload positions without any liquidity or bid in the market. A unique event, but one that reflects how financial markets can become very dysfunctional very quickly when things go bad. 

And while it wasn’t a good day for the oil majors, Chevron and Exxon Mobil fell around 4 per cent, hardly the meltdown suggested by the front month implosion. The kind of dislocation witnessed yesterday, however much some may downplay it, points to a fundamental problem in oil markets, namely a lack of storage capacity and demand. But it also shows the market trying to do its job, forcing the price down enough to shut production. The problem is closing down production sites is not that easy and not cheap, so producers are desperately trying to avoid it.  

Donald Trump says he will add 75m barrels to the US SPR – always one for a deal. OPEC is said to be looking at cutting oil output immediately, rather than waiting until next month. You should note that Brent is much more stable, albeit still pressured to the downside, as OPEC+ cuts are due to take effect and storage constraints are less pronounced.  

WTI – for Jun – was down testing the $20. It’s hard to see how it can hold up against the immense pressure from the lack of storage. 

Equities are only 15 per cent from their February all-time highs, but the world seems ‘more than 15 per cent screwed up’. That’s how Howard Marks, the co-founder of Oaktree Capital Management, summed up the current state of the bear market rally while talking to CNBC yesterday.   

The S&P 500 finished the day lower by 1.8, with futures pointing lower again today and now under the 50-day moving average. European markets are softer, with the FTSE 100 trading under 5700 but remains in the bullish channel, with support coming in at 5600. The DAX is testing trend support around 10,500. The oil market stress is affecting equities, with oil majors under pressure today. Also we need to consider the potential stress in the banking sector - Wall Street is on the hook for about $200bn in loans to US oil.

 

In FX, the pound retains its bearish bias with GBPUSD making fresh lows overnight before bouncing back into the horizontal channel that has dominated since last Wednesday. The 1-hr MACD may be about to show a positive move. Price action is anchored on the lower Bollinger band.

 

 

Neil Wilson is chief markets analyst at Markets.com