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This week started with a collapse in the crude oil price to levels not seen since 1999. Rising production and collapsing demand due to the COVID-19 pandemic is causing an unprecedented glut in the oil market. As a result, we are currently witnessing a pronounced supply and demand shock that has resulted in a 20 year low for oil prices. Indeed, on Monday we saw a negative price on the futures market for oil delivery in May 2020 – suggesting suppliers need to pay the consumer to offload oil in the next month!
At the current pace of production, global oil storage capacity will be filled by the end of the second quarter. This situation is already causing price pressures at oil wells, where oil producers are finding it increasingly difficult to sell their inventories.
The major oil producing countries have now agreed to cut production to try to avert the crisis. However, the COVID-19 pandemic has led to the implementation of rigorous measures globally to contain the spread of the virus. Travel restrictions, social distancing and stay-at-home orders have reduced global oil demand by an estimated 5.6 million barrels per day in the first quarter of 2020 relative to the first quarter of 2019. This situation is expected to worsen in the second quarter.
Almost 58% of global oil demand is derived from fuel for transportation. The impact on demand, and thus the oil market, is significantly worse than in normal recessions because of the widespread implementation of travel restrictions, which has reduced global air traffic by 30%. Quarantine measures have also caused a significant drop in road traffic, by roughly 40%, leading to a large drop in demand for petrol and diesel.
The imbalance in oil markets was exacerbated in early March, when Russia and Saudi Arabia could not agree on production cuts. In fact, quite the opposite took place as Saudi Arabia, in retaliation, started a price war by giving rebates on their crude oil exports and announced an increase in production starting in April. However, the steep fall in oil demand and rapidly rising inventories have now convinced the world’s top producers to reverse course.
It is often in challenging times like these when the foundations of the next upswing are laid. The weak players in the oil market are dropping out and exploration companies are significantly reducing their capital expenditure. Today’s cancelled projects will be missed in three years’ time. Companies that survive the “Great Glut” may be able to look forward to a more balanced oil market in the next five years than they have experienced in the previous five.
Closer to home we now have another three weeks of isolation to look forward to. News flow this week has been focussed on discussions around how the UK might finally exit from lockdown, with splits becoming evident in Westminster and the medical community on how best to proceed. The UK stock market has become weighed down by company earnings reports and prolonged lockdown concerns. Today, the Bank of England said it would keep holding weekly auctions of one-month and three-month sterling funds under its emergency Contingent Term Repo Facility (CTRF) until the end of May, extending a measure to calm coronavirus-related market tensions.
In summary, we are continuing to work hard within the confines of the COVID lockdown. Client portfolios have a had a much better month and our investment team are finding opportunities in technology and healthcare that are adding significant value to client portfolios.
That leaves me to wish you are your family all the very best and I hope that this update finds you all safe and well. As usual, should you have any questions, please do not hesitate to contact your adviser.