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The Latest Virus Victim - Oil

April 27, 2020
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Monday Morning QB - Market Observations:

  • Tumultuous Week in the Oil Market as Oil Prices Collapse
  • Worst Week for U.S. Crude Oil Futures Ever… As Price of Crude Oil Briefly goes Negative
  • Crude Oil Problem - Lack of Demand Meets Lack of Storage
  • U.S. Economy Experiencing the Largest Demand Shocks Since the Great Depression
  • Two-Week Stock Rally Takes a Pause... Rally Concentrated in Large Cap Growth Stock Favorites
  • Unemployment Claims Total 26 Million Over 5 Weeks...16% of Workforce
  • Markets Reacting Well to Weak 1st Quarter Earnings- Reports Which Include Little to No Future Guidance
  • Premature Reopening of U.S. Economy is Biggest Risk for Stocks
  • The Unknowns and Uncertainties Suggest Maintaining a Higher than Normal Cash Position

Monday Morning QB - Market Performance:

Most of the major indexes fell moderately last week as investors digested first-quarter earnings reports and the plunge in oil prices.

The Dow Jones Industrial Average gave up 467 points to finish the week at 23,775, a decline of -1.9%. The technology-heavy NASDAQ Composite gave up just -0.2%, finishing at 8,635.

By market cap, the large-cap S&P 500 declined -1.3%, while the mid-cap S&P 400 fell -0.7%. The small-cap Russell 2000 went the other way, finishing the week in the green, up +0.3%.

Unprecedented Collapse in Oil Prices

It feels like every week the MMQB details another never-seen-before market collapse. Last week was the oil market's turn.

Shutting down the economy continues to wreak havoc in ways that keep catching us off guard but in hindsight seem obvious.

The issue is more about the unthinkable magnitude of recent events than the event itself.

When the global economy comes to a standstill, we will use less energy, causing the price of oil to drop. Declining prices are one thing, but negative prices are something else altogether.

A week ago Friday, West Texas Intermediate (WTI) crude oil prices ended the week at $18.27 a barrel. (It was not that long ago that the cost of oil was fluctuating between $40 to $60 a barrel.) WTI finished last week at $16.94 a barrel.

If you were not paying attention, one would wonder what all the fuss was about.

Last Monday, the price of a barrel of oil to be delivered in May, fell to negative$37.63 per barrel. On Tuesday, the U.S. oil contract for delivery in June collapsed 43% to $11.57 per barrel.

The decline in price is due to the supply and demand imbalance for oil. Oil is still being produced, it’s just not being used.

Rates are adjusted based on the expected future supply and demand needs for energy.

Oil contract prices differ by the delivery month and are referenced by the “Futures Contract” for the month of delivery – the June contract, July contract, August contract, etc... Each month carries a price for oil, which will fluctuate until we get to the actual delivery date.

The questions for oil traders are, "Will the June contract follow in the footsteps of the May contract and fall below $0 as we get closer to the end of the month", and then, "Will we experience the same thing again in July, August, September?" and so on.

At some point demand will return but, until then, the final price for every month’s oil contract is a huge question mark.

So What Happens to All the Currently Unwanted Oil?

You what to be a billionaire? Store oil at the current prices and hold it until this whole virus mess comes to its inevitable end. At that time, the need for oil will return and the price will move higher, sell your stored oil and make a fortune.

Sounds easy enough, but storage for oil has become a real problem.

A scene playing out around the world is that oil tankers full of oil must “shelter in place” off the coast of cities where refineries are located until the oil is needed. The price of oil collapsed because there is simply no place to store it!

According to an article I read in the Wall Street Journal, the world produces around 100 million barrels of oil per day. With most of the world still under the “shelter in place” order, the daily demand for oil has fallen to around 70 million barrels per day. Global onshore storage facilities are taking on 10 million barrels a day and are currently about 65% full.

The article suggested that the storage facilities will be at capacity in roughly 100 days.

With the onshore facilities filling quickly, oil producers are leaving the oil in the tankers waiting for delivery. According to the Wall Street Journal article, the volume of oil stored on ships is up 76% from March 1st. There is now, resting in boats offshore, between a 1 to 2 day supply worth of global oil production. This equates to roughly 153 million barrels of oil!

In response to the lack of demand for oil, companies have begun “shutting in” their oil wells. The longer the displacement in oil supply and demand lasts, the more oil companies run the risk of going out of business.

This extreme example of supply and demand dysfunction will continue to worsen if the oil that the world’s stalled economy would otherwise be using runs into a dwindling capacity to store it!

Will the same supply and demand issues in the oil market play out in other markets as well?

Based on the stock market performance so far in April, many are hopeful that the oil market is an isolated issue and the unprecedented stimulus response from both the Federal Reserve and Congress will continue to push the stock market higher.

(sources: all index return data from Yahoo Finance; Reuters, Barron’s, Wall St Journal, Bloomberg.com, ft.com, guggenheimpartners.com, zerohedge.com, ritholtz.com, markit.com, financialpost.com, Eurostat, Statistics Canada, Yahoo! Finance, www.stocksandnews.com, www.chaikinanalytics.com Chaikin Analytics, www.marketwatch.com, www.BBC.com, www.361capital.com, www.pensionpartners.com, www.cnbc.com, www.FactSet.com, W E Sherman & Co, LLC)
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