Each week Josef Schachter will give you his insights into global events, price forecasts and the fundamentals of the energy sector. Josef offers a twice monthly Black Gold newsletter covering the general energy market and 30 energy and energy service companies with regular updates. He holds quarterly subscriber webinars and provides Action BUY and SELL Alerts for paid subscribers. Learn more and subscribe.
Negative Oil Pricing: WTI prices shocked investors by going negative on Monday April 20th as crude oil futures speculators overstayed their welcome and did not close out their holdings a week or more before the Tuesday April 21st expiry, as should have occurred. Normally those long maturing futures contracts have three choices: sell the contract, prepare to take delivery (usually commercial refiners or other users but not speculators) or roll the contract to a future period. With storage tight the normal physical commercial buyers of month expiry crude had no place to put it so the little storage left allowed the commercials to take advantage of the distress of the pigeon speculators. This caused panic in the speculative holders and they were forced to pay $US37.63/b to commercials to take the oil off their hands before the expiry. On Monday the May contract fell US$55.90/b to a low of -US$40.32/b before settling at -US$37.63/b. The speculative pigeons got fleeced for not exiting quicker. Of interest the June contract closed that day at US$20.43/b. The Brent contract did not have the craziness of WTI as that contract had already rolled over to June.
There are over US$600 Trillion of derivatives available with most in the debt area. The energy area is seeing major leveraged investing via the futures, via options on futures and via investments in ETF’s that can be one time or two or even three times leveraged. As prices move quickly the ETF’s can blow up if the market goes against the direction of the ETF. In the US the largest bullish energy ETF – USO (fund value US$4B) owns 25% of the June WTI contract (after rolling from the May one) and it plunged from US$6 per share to US$2.31 in under three weeks. In Canada, the Horizon ETF the HOU.TO fell from $9.29 per share on April 3rd to $1.12 per share on April 21st. This volatility is not normal and has caused bullish investors to be concerned about what they bought and not understanding what they bought. If it had gone the other way they would be rejoicing but this downside pain has frightened speculators who were not expecting such a meaningful decline. On the opposite side the crude oil bears owning the Horizon HOD.TO ETF saw a move from $5.61 per share on April 9th to $33.50 per share on April 21st. We do not cover ETF’s and have not recommended them and this speculative volatility is why.
Last week’s holdings report from the CFTC showed that speculators own on April 14th, 501K contracts for 501Mb of crude (contracts of 1,000 barrels each) and up from 428M barrels on March 31st. Commercials on the other hand have 552Mb short up from 481Mb short on March 31st. Historically at market bottoms it is the speculators who have liquidated their longs and gone flat or short, while the commercials have gone to a net long position. With the current holdings levels this does not support the view that the low for crude prices is in. We fear that the June and maybe even the July rollovers could see negative pricing unless the economy is reopened. The June contract that ends on Tuesday May 19th, will surely have a negative price at its end but the July one will require a lift in energy consumption of some significance so that the demand meets the supply at that time and there is no need to store crude when the contract matures.
EIA Weekly Data: Wednesday’s (April 22nd) EIA data was again mostly negative with an overall commercial stock increase of 15.0Mb (versus last week’s rise of 19.2Mb). A big part of the build was due to a fall in exports of 546Kb/d or 3.8Mb on the week and distillate inventories which rose 7.9Mb on the week. Gasoline inventories rose by a modest 1Mb versus last week’s 4.9Mb. Overall storage rose by a whopping 25.5Mb on the week. US production of crude fell 100Kb/d to 12.2Mb/d and is now 900Kb/d below the peak of just over a month ago. Production cutbacks keep on being announced and as storage fills we should see more production being shut in for high cost shale plays and low volume stripper wells. By early summer US production is likely to be under 11.0Mb/d and maybe by late summer under 10.0Mb/d; if quarantining has not been lifted throughout the country and demand has picked up materially, lifting crude prices. Cushing saw a rise in storage of 4.7Mb to 59.7Mb and may have a month left until full (effective capacity 76-77Mb). Whatever remains of storage has been taken down under contract so it is impossible for those without contracts to store oil in this key storage hub.
On the positive side this week product consumed, lifted by 306Kb/d to 14.1Mb/d the first increase since the start of the slide as the Covid-19 virus closed the US economy down. Finished motor gasoline lifted by 230Kb/d to 5.3mb/d and jet fuel surprisingly rose by 148Kb/d to 612Kb/d. These are encouraging early signs that at least a base level of demand remains. Hopefully we do not see a pick up in Covid-19 cases as the country slowly emerges from the shutdown resulting in mitigation requirements stiffening again.
Baker Hughes Rig Data: Last week Friday the Baker Hughes rig survey showed a decline in the US rig count of 73 rigs (prior week down 62 rigs) to 529 rigs and down 48% from 1,012 rigs working a year ago. The Permian felt the largest loss with a rig loss of 33 rigs or down by 39% from a year earlier. We expect the US rig count to fall to 400 or less in the next few weeks. With high depletion for new wells this supports the view that the US production could fall to 10.0Mb/d in Q3/20 if crude prices remain low. Canada had a decline of five rigs, and the count now is at 30 rigs working down 55% from 66 a year ago. It is likely that 700Kb/d has been shut in already in Canada during Q2/20 and maybe a total of 1.2-1.6Mb/d before the end of Q3/20, if prices for WCS remain below operating and transportation costs.
Conclusion: WTI as we write this is at US$13.95/b for the June contract. To put that into perspective that compares to the June Brent contract at US$19.80/b and the forward July WTI value of US$20.46/b. The numbers are changing so fast it is hard to keep track of the various contracts. The farther you go out the higher the contango value. Into 2021, you can see WTI prices over US$30/b. We expect to see negative pricing for the June contract before expiry as there will be less storage by mid-May and this will drive crude prices lower again. The current price recovery won’t last. Our target is for crude to fall into late May or late June before reduced supply and reduced demand balance out.
The S&P/TSX Energy index now at 64 should fall to the 32-36 level in the coming weeks before we see a final bottom. The recent bear market short covering rally over the last five weeks of 75% is now spent at the high of 71 and we see it falling over the coming weeks by nearly 50%. The short covering rally that took the S&P Energy Bullish Percent Index from 0% on March 9th to 92% last week is rolling over and is now at 67%. We expect to see it fall below 5% again, as the overall stock markets plunge.
We got a BUY signal from the Energy Bullish Percent Index on March 13th and added eight new ideas to our Action Alert BUY list. These stocks have done quite well on the recent rally. We expect to see another below 5% BUY signal in the coming weeks as crude falls and the Dow Jones Industrials Index plunges below 18,000 (now 23,540). The overall stock market plunge will be likely due to poor Q1/20 earnings, negative outlooks by companies, and the too slow arrival of stimulus funds. This is likely to weigh on stock markets. The longer the delay in getting adequate testing kits and the longer the delay in reopening the economy, the lower the markets may go. The US States want to start extensive testing and tracing and need test kits which are not readily available. If we are to see a reopening of Canada and the US we will need to be able to do significant testing and require quarantining of those infected. A slow phased reopening of both economies is the best potential outcome. For us in Canada that means July or August for the first phases. We are a long way away from going to movies and sporting events.
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