20th April 2020 will be a historical day when once most desired commodity that resulted in war entered into negative price. But what led to this negative price and does this have any relevance to physical markets and consumer countries like India ?
First we will discuss various reasons that led to possibility of negative price for oil:
Physical Oil Market :
1. If we look at physical market then due to global shutdown there is reduction in demand of oil by 20 million barrels per day. A major factor of demand drop is due to majority airlines running minimum operations estimating a 45% drop in jet fuel demand by second quarter.
2.OPEC+ involving G20 countries agreed on cut of 9.7 million barrels per day that would translate to only 7.2 mn bbl/day.
3.Physical capacity to store oil globally is running out at very high speed that led to force majeure being decalred by global and Indian refineries.
USA Oil Future Market :
1. On 15th April 2020 , CME ( largest commodity trading exchange) issued an advisory that certain NYMEX futures can trade at negative or zero prices , also settle at negative or zero prices due to current oil market environment.
2. On 16th April 2020 US Commodity Funds that manages United States Oil Fund ( largest oil etf ) with asset size of $3.9 Bn will shift to later date future ( 2 month future) from 100% near month future (1 month future). 20% of assets will shift on 17th April 2020 and rest will shift in foreseeable future.
3.WTI futures delivery is taken at Cushing, Oklahoma where the capacity was filling up fast. It was at 77% capacity as of last Friday.
RESULT OF EVENTS ON 20th April 2020 :
As per settlement cycle May futures are to expire on 21st April 2020. And the changes made in USO resulted in major issue that would otherwise go smoothly as the rollover of futures do not have high rollover cost. But due to such changes most of liquidity of May future evaporated post 17th April and there will still large number of contracts outstanding.
This resulted into heavy liquidation of May Future yesterday with low buying interest that made prices go to -38/bbl. But the benchmark and USO funds have already shifted majority assets to June futures that still fell 15% yesterday but trades at around $21/bbl as seen below.
Due to shift in asset allocation to June futures, USO saw a drop of 10% in NAV as compared to drop of 300% in WTI May futures.
WHAT TO EXPECT NOW ?
Though the expiration of WTI May future is today, there will still be volatility in prices. But this does not mean that June Future does not have scope of similar situation.
Three factors that will impact June Futures and WTI prices :
1. USO will start reallocate its assets on May 5th-8th to July futures as the policy shifts to have assets in later date contracts.
2.Storage capacity of futures deliveries at Cushing is almost full and physical global market capacity is also running out with production cut to become effective only in May second half even if all the countries speed up the process.
3.Investors of USO have seen a large destruction of wealth in past two days , there would be heavy redemptions in the ETF that will impact future outstanding contracts next day.USO accounts for 30% of outstanding contracts of WTI June Future.
HOW IT IMPACTS INDIA ?
At first thought it is obvious that India will benefit of such a situation given that it is second largest consumer of oil. But the current environment of a lockdown does not help take the advantage even if we reopen soon.
1.The current import of oil has reduced by almost 50% in volume to 2.3 mn bbl/day from 4.2 mn bbl/day. This will take long time to normalise for the benefit to reflect.
2. IOC along with other major refineries have declared force majeure for the some oil purchase contracts.
3. Fuel demand is 50% down in first two weeks of April led by 61% fall in Petrol , 64% fall in Diesel & 94% fall in ATF. This has resulted in OMCs to keep the price unchanged during the lockdown period where global fuel prices are below $1 per gallon.
4. India Strategic Petroleum Reserve (SPR) is only 37 million barrels that is equivalent to 13-16 days usage at current rate of consumption.
We expect the Crude prices to remain low with further downside risk as the demand side will take long time to recover. But we disagree that India will not benefit much of these prices as the import volumes are also impacted by large portion.