Oil price in USA, for the first time in history, plunged into negative US$37 yesterday.
You must be wondering, how can oil price goes to negative?
Since I was previously primarily in the Oil and Gas industry, I remember 2008 when Oil hit $147 per barrel, and now imagine it is worth nothing.
How can it be?
To explain, Oil is a commodity traded on its future price. This means that you can buy Oil contracts now but the delivery is in May, or in June, or in July. Each contract trades last a month.
Another term which you probably needs to know is Contango which is the current oil situation. Contango means the price of spot price is lesser than the forward futures’ price. This means oil is expected to be more valuable in future, when demand rise again. Currently there is a huge contango, meaning the front month oil price compared to the second month oil price exists a huge spread.
If buyers are able to find a place to store the oil, there is possibility of huge gains. However, the strategy is dependent on locating a storage facility and managing that expense, as well as actual major changes in global demand.
STORAGE IS FULL
The largest oil depots for storing the big stockpile of WTI oil in USA is a place call Cushing in Oklahoma, and tank farms of 76 million barrels are to the brim. Operators are fully booked. Storage jumped by 5.7 million barrels the week before. To add pain onto the onshore glut, there are also ~160 mil barrels of oil offshore on tankers waiting for buyers.
In simplest terms, the negative oil prices means the oil producers or sellers instead of selling, are now willing to pay buyers to take oil off their hands amid fears that most storage facilities will run out of space by the end of May.
There are speculative traders and real buyers (e.g. refineries) who needs the oil. And as contract settlements in May nearing with no more storage space, the speculative traders of the oil who does not need the physical oil is desperate to sell the contracts they owned. But there isn’t so many real buyers due to low demand.
Hence, if the speculative cannot find buyers of the oil for May, then they will have to end up taking the physical delivery of oil, with no place for storage. That is why they are desperate to sell even when it means paying money for the other party to own the oil contract. Hence at negative 37 bucks, meaning they are paying the buyer $37 a barrel to own the oil.
On Monday 20 April is the last day to settle the contracts for May. Oil prices began to rise again on Tuesday today 21 April as oil traders turn their attention to trading oil for delivery in June. Contracts not closed in May can be rolled over to June, but because of the contango resulting in huge spreads, it will result in big losses.
WHY NO DEMAND
This is obvious, thanks to Corona virus which essentially shut down the most of the USA economy leading to low demand. The crisis was further compounded after Saudi and Russia engaged in a price-war to increase supply. Although cuts of 10 million barrels were further agreed, but market fear that the cut is insufficient.
HOW ABOUT OIL COMPANY LIKE EXXON AND SHELL?
You can check their share prices which drop in share prices pale WTI plunge. These oil giants are comparatively less affected as their business are diversified into exploration (Upstream), refinery (Downstream) and Chemical etc. And these companies are not merely oil producers but also natural gas and chemicals sellers. These companies also invest long term into Upstream exploration business which involves projects that will only materialise few years later before the first oil is produced.
There is also a reason why you do not find Petrol of your car as cents per litres because it involves refinery and transportation costs etc. This is where Exxon or Shell refineries earn their profits. In fact the cheaper the crude oil, the lower the material cost for refiners.
HOW ABOUT KEPPEL CORP AND SEMBCORP?
Likewise, Keppel Corp and Sembcorp who saw little decline in share price. Both Keppel and Sembcorp had been in progress of diversifying out of the Oil and Gas market since the 2015 oil crash which also revealed corruption cases in Brazil. Keppel has property businesses, Data REIT, Electricity, Infrastructure businesses etc. Sembcorp is involved in utilities, environment and energy, water industries etc with clients spread over the region in Asia, UK and ME. Hence, the fall in pricing is not as drastic even when oil price tumbles yesterday.
Nonetheless if oil demand continues to lag supply, it is a matter of time where these stocks will have share price sliding down too.
USA is the largest producer of oil due to shale discovery in the last decade. With oil price hitting the floor, many oil producing companies are expected to go bust. Shale producers will be hit hard first due to their higher cost of producing oil compared to the traditional oil exploration of Middle-Eastern countries in particular. Also, USA is also 3rd largest oil exporter. With oil price tumbles, revenue of the country will plunge as well.
Oil exporting countries who derived most of the revenue from oil are also going to suffer badly. Saudi is top exporter followed by Russia. Their move to increase supply few weeks back has backfired and slapped their own cheeks reducing their own countries’ revenue significantly.
Although internationally, the benchmark for oil is Brent Crude which is below US$20 per barrel, it is also a matter of time due to low demand, there will be the same problem as WTI.
Nearer to home is Malaysia, who is also net exporter of oil. If oil price declines greatly, the country’s budget deficit will rise. It is double whammy considering the shut-down of the country now due to Covid-19.
Singapore is net importer of oil, so we will be less affected. That said, the impact of historical low oil price will without doubt also have psychological repercussions to the local market.