Sheer chaos in crude has managed to slam the brakes on what’s still generally being described as a “bear market rally” in stocks off the March lows.
US equities have fallen nearly 5% in the new week after gaining some 15% over the previous nine sessions. Tuesday’s one-day decline was the largest in three weeks.
But the story isn’t stocks right now. It’s oil. June WTI futures fell below $10 on Tuesday. CME said the contract was halted several times for volatility. The plunge underscores the extent to which the real problem is the fundamental backdrop – that is, a massively oversupplied market. There’s too much oil, nobody wants it, and even if they did, there’s nowhere to put it. We’re in surreal territory now.
Retail investors in USO are getting a crash course in roll dynamics. After halting creations pending approval of new shares (amid massive inflows over the past six days) the biggest oil ETF filed a second 8K on Tuesday afternoon, informing investors that 5% of its holdings are now in the August WTI contract. The rest of its futures exposure is split between the June (40%) and July (55%) contracts.
This is, in short, as mess. “In response to ongoing extraordinary market conditions, including super contango [USO] may invest in the above described crude oil futures contracts… in any month available or in varying percentages or invest in any other of the permitted investments described… in its prospectus, without further disclosure”, the fund said, in the linked filing. “USO intends to attempt to continue tracking USO’s benchmark as closely as possible, however significant tracking deviations may occur”.
Again, it’s a problem, and as Nomura’s Charlie McElligott wrote Tuesday, there’s some chatter around the possibility of a “lights out” scenario. He called it “an additional hypothetical”, noting that “despite there not being a redemption mechanism, there is certainly a scenario where if June futures were to also go negative, then USO would be ‘lights out’ as a partnership and could actually ‘owe’ money”.
This is an extremely fluid situation, but as Bloomberg’s Luke Kawa noted in his coverage, “an exchange-traded fund has not and cannot trade below zero”. USO’s prospectus, on the other hand, says “no level of losses will require USCF to terminate USO”.
Draw your own conclusions, but whatever the case, we’ve entered a not-so-brave new world, that’s for sure.
“The implications of this crude move are obvious and frightening, with almost certain energy sector bankruptcies now likely to accelerate and with both the bonds and stocks of the most leveraged firms trading like they’re imminently ‘filing'”, McElligott went on to say Tuesday, adding that “bank loan-loss provisions continue to look ‘under-marked'”.
Citi broke out its unfunded exposure to the energy sector in its quarterly results. The visual below shows you what that exposure looks like (the chart isn’t meant to be suggestive – it’s simply derived from the bank’s earnings release last week and presented “as is”, so to speak).
One executive at an oil-field services company predicted a “tidal wave of bankruptcies” in comments to Bloomberg.
Desperate, The American Exploration and Production Council is putting pressure on Bob Lighthizer to ask China to speed up the $52.4 billion of US energy Beijing agreed to purchase as part of the “phase one” trade deal.
“China has only purchased a de minimis amount of US crude in the first months of 2020, while it has increased purchases of crude oil from Saudi Arabia and Russia”, the council’s CEO seethed. “Rather than increasing imports from countries like Russia and Saudi Arabia, the Chinese government must take the necessary steps to remain in good standing with the US as a trusted trade partner”.
As a reminder, there are serious doubts as to whether China will make good on its commitments under the trade pact in light of the economic fallout from the COVID-19 epidemic.
The supply/demand imbalance isn’t set to abate anytime soon. The OPEC+ cuts aren’t even implemented yet, and demand destruction from the containment measures associated with the global effort to stop the spread of the virus is likely to hang over the market for months, if not longer.
In short, the glut is going to persist. “The market needs shut-ins to happen now”, Pierre Andurand told Bloomberg TV on Tuesday.
“Further [large] storage builds… are likely because the weakness in oil-product demand is only now spreading into refinery demand for crude oil”, Deutsche Bank said Monday evening. “There is potential for refinery runs to catch down further towards product demand weakness”, the bank went on to write, noting that “even with oil-product demand staying the same this week, there could be further decline in refinery runs, and with it, crude-oil inventory builds, unless offset by production decline”.
Speaking of production declines, some OPEC ministers held what the cartel called an “informal teleconference” on Tuesday. Nothing came of it other than a nebulous commitment to the already-announced cuts. There was no mention of additional measures to help ameliorate what is now a full-blown meltdown, although the Iraqi oil minister didn’t rule out further steps.
Donald Trump, meanwhile, is “formulating a plan”.
“We will never let the great U.S. Oil & Gas Industry down”, the president tweeted. “I have instructed the Secretary of Energy and Secretary of the Treasury to formulate a plan which will make funds available so that these very important companies and jobs will be secured long into the future!”
On Monday, Trump again said he wants to “top off” the Strategic Petroleum Reserve. Energy Secretary Dan Brouillette is angling to convince Congress to snap up crude at rock-bottom prices. The DOE already has a scheme that will pay producers to keep oil in the ground.
The same executive who warned of a “tidal wave” of bankruptcies summed it up best. “Oil and gas has suddenly become a hobby that only the best capitalized companies in the industry are going to be able to continue to enjoy engaging in”, he said.
“Mark it zero”, folks. Mark. It. Zero.
I want believe that you closed this article with reference to Walter Sobchak.
Over the line!!!!
While the oil gangsters falling out happened “before Covid19”, it was noted in earlier H posts that demand destruction was completely predictable.
Certainly geo-realpolitik is at play too, but oil usage is of course related to pandemic lockdowns and the current economic Depression is also related to credit/currency crunches.
There is no normal, plan accordingly.
To ‘save’ the energy markets we would have to monetize the markets with a massive subsidy and harsh tariffs, effectively picking winners and losers. With the size of the energy markets it seems impossible to think that the US government can monetize it. Or am I being too pessimistic?
Oil beat Bitcoin to zero. Who’d have thunk?
“The Chinese government must take the necessary steps to remain in good standing with the US as a trusted trade partner”.
Clowns to the right and clowns to the left! I live in Alaska and this oil thing is going to be devastating in that we are not out of the last local recession (2014) yet and have done absolutely nothing forward looking; we’ve been hanging on the oil teat far too long and spending as if something like this would never happen. Along with that, Alaska is red on red in red politically and thus anything that walks like a tax is assassinated during its first step. But I believe it’s going to be one of the best things that’s happened in my 50+ years here – a giant toilet flush. It turns out that there are actually going to be some ‘good’ things wrung from all this.