“It’s more of a financial thing than an oil situation”, Donald Trump said, reflecting on an unprecedented collapse in crude that saw May futures wiped out on the way to settling deeply negative during a session that will live forever in market lore.
The president brushed it off. “[It’s] largely a financial squeeze”, he went on to remark.
As usual, Trump is both correct and incorrect at the same time, which tends to happen when you speak in wholly nebulous terms on things you know very little about.
Perhaps the key takeaway from the oil industry’s “devastating day” (as one hedge fund investor put it), is that the world’s most financialized commodity became less than worthless due (somewhat ironically in that context) to physical constraints.
That assessment (as it appeared in my own postmortem) was echoed by RBC in a Monday note. “This day of reckoning comes simply because the financial pricing has to converge to the physically traded commodity on contract expiry”, the bank wrote. “In other words, the paper market and the price of the underlying commodity have to converge as physical barrels prepare to deliver”.
I’ve said it before, and I’ll say it again: There’s too much damn oil, nobody wants it, and even if they did, there’s nowhere to put it. If things keep going like they’re going, Cushing will be full by the end of next month, apparently.
“US storage is full or committed”, the same hedge fund manager quoted by Bloomberg in the first linked post above said.
All of the commentary has the same fatalistic overtones. COVID-19 has delivered a demand shock too acute to overcome. The nail in the coffin was the rift between Riyadh and Moscow that led to further flooding in an already oversupplied market. Now, it’s game over – in an almost literal sense.
The rush to get out of the May contract produced a veritable smorgasbord of dramatic visuals on Monday, including an explosion in the front-month spread amid acute concerns over where to put physical barrels. Goldman says you can expect the June contract to see “downward pressure next”, and called the situation indicative of an unprecedented surplus.
Volatility absolutely skyrocketed. The spikes associated with last summer’s soap opera in the Strait and the September attacks on Saudi oil infrastructure now appear as mere blips. Even the volatility that accompanied the collapse in prices stemming from Riyadh firing the opening shots in the price war last month seem tame by comparison.
“[This] could result in several shifts in risk management protocol’, Axicorp’s Stephen Innes wrote, following the dramatics. “First, we could see some reallocation of assets out of futures into more stable Oil proxies, second, calendar roll decisions could be brought forward, and third, there could be flat out liquidations”, he went on to say, before cautioning that “all three options could potentially put more pressure on oil prices over the next few weeks [and] my guess is these are [already] happening”.
Needless to say, this runs counter to central banks’ efforts to reflate the global economy and speaks to why there is still extreme trepidation in some corners about the prospects of an upturn in inflation expectations engendered by various forms of stimulus, both monetary and fiscal.
This collapse in crude is, to put it colloquially, a deflationary supernova.
Trump on Monday said the current situation will be “very short term”. He also reiterated his intent to buy crude for the Strategic Petroleum Reserve, which the administration has variously vowed to “fill up”. “That would be the first time in a long time it’s been topped out”, Trump said. “We’ll get it for the right price”.
“This is a great time to buy oil”, the president added.
With all due respect, not everyone seems to agree.
Sorry, novice question here:
Isn’t the US shale product too “light” for most US refiners to turn into gasoline?
If so, what good does it do the Pentagon to possess a bunch of oil that can’t be processed into gasoline for its tanks and fighter jets?
Similarly, if we can’t vertically produce our own gasoline for US drivers, then how is that reserve of oil “strategic” in any way?
Any comments would be appreciated.
Gasoline is not diesel in its varied flavors. Although the pentagon has gasoline needs, they are not the same as JP4 that powers tanks and aircraft. We DO “produce our own gasoline for US drivers.” Gasoline is produced here. There are no gasoline tankers sailing the seas.
Refineries are very complex processes that can only be fully understood by understanding that it is a business of molecules. That said most large US refiners are ‘tooled’ to process discounted high sulfur heavier sour grades as they get the oil at a discount. This includes cracking, alkylation, hydrogen production, hydrogen purchase, and sulfur recovery units, units that have been fully depreciated in USA large refineries.
Not strictly speaking but generally WTI processing is not as complex for certain molecules. To the degree if the molecules sought out by the markets are what are in the WTI (WTI is sort of a misnomer as each WTI source has a different molecular sprectrum), then sweet crude can be fractionated in the crude unit and sold in current market conditions. In fact WTI sells in the export at a premium to heavy sours to teapot kettle refineries such as island or smaller countries that do not have the volume to justify the more complex processing units. However these simpler refineries produce vacuum bottoms that have very low market value and have been sold as Bunker C or added to asphalt. Yes a refinery ‘tooled’ for heavier crudes can be simultaneously ‘tooled’ for WTI by addition of overhead condenser on the crude tower, this does not pay the bills as well as the molecular control given to the refinery with the more complex processing units. Generally I believe Diesel or turbine fuel is not as economically derived from WTI than other crude grades.
This description is a bit less than the Cliffe Notes version, but that is it appears what you are asking for.
I did not directly answer your question. Since refining is a business molecules refineries are typically more profitable with a mixture of crudes to best hit the refinery processing limits. The processing limits can show up anywhere in the refinery. So storing some WTI in addition to the heavy crudes in the SPC is really not a bad thing, may help balance the market should it be needed. That said I think there is less need for SPC these days with all the capability to ramp up production. While yes it can be difficult to do so over the last 10 years we have seen a veritible explosion in infrastructure investments, sand mines, pipelines, water processing etc. Those infrastructure investments were mostly what was constraining ramp up in the boom years, not people or frack trains.
Great time to buy oil if you have somewhere to put it. My daughter texted me that she was hoping someone would pay her to fill up her bath tub. But since she is smarter than Trump I’m assuming that was a joke. 😚
Deflationary Supernova? That my friends, is poetry
No, it’s not poetry. It’s quantum physics. A “deflationary supernova” would otherwise be called a “black hole” from which no light or information escapes.
Well, then, it is certainly poetic physics