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Don’t Believe The Oil Bulls

Nick Cunningham

The world surplus could reach 20 million barrels per day (mb/d) in the next few weeks, threatening not only to top off storage tanks everywhere, but to crash prices even further and shut in oil production. 

The shutdown orders in the U.S. continue to multiply, confining tens of millions of people to their homes. Much of Western Europe remains on lockdown as well. 

The impact of this pandemic will only grow as the U.S. has failed to contain its spread. Cases are doubling every few days, and state governments are rushing to impose stay-at-home orders. The response is scattershot, much too late and still much too permissive to stop the spread. But large-scale home isolation is now the only option to mitigate the damage. 

“Developments over the past week in terms of the spread of the coronavirus in the US and in the policy response to it, imply to us that the fall in US demand could be as high as 7 mb/d in the worst month,” Standard Chartered analysts wrote in a note on Tuesday. 

The deterioration of the situation in the U.S. is throwing a wide range of oil market forecasts out the window. As recently as March 17, Standard Chartered estimated a global surplus of 13.4 mb/d in April, “but now see a risk that the April surplus could exceed 20 mb/d.”

It’s a staggering conclusion. The prior estimate of a brief 13.4 mb/d surplus followed by months of a narrower overhang was already large enough to lead to storage capacity filling up by the end of the year. 

But if the more dire forecast of a 7 mb/d drop in demand in the U.S. bears out for April and May, global storage could fill up as soon as the second quarter rather than the end of the year, Standard Chartered said. 

Related: Canada Braces For Oil Cuts As Storage Nears Limit

“The short-run implication for the market is the same: prices are likely to fall further and some higher-cost supply will need to be shut-in,” the bank warned. 

Which producers are most vulnerable? “We see Canadian oil sands, the North Sea and Latin American heavy production as being the most vulnerable to a sustained period of lower prices, with further supply reductions coming from US shale when completions are no longer able to offset m/m declines,” Standard Chartered concluded. 

With oil prices in the $20s, Texas oil regulators and OPEC officials find themselves talking about some theoretical coordinated production cut. But against a backdrop of a 20 mb/d surplus, that idea is as fanciful as it is trivial. 

It seems extremely unlikely to happen anyway, but so what if Texas regulators decide to impose a 10 percent cut in the state’s production? At 5.3 mb/d of production, a 10 percent cut would translate into a little more than half a million barrels per day. 

Output in Texas could fall by much more than that this year regardless of what regulators do as shale drillers find themselves in financial ruin. Oil prices in the teens or even lower will be a more powerful regulator of U.S. oil production than the Texas Railroad Commission. 

An initial estimate from Rystad Energy says that U.S. shale capex will fall by a third to $64 billion in 2020, but spending will shrink by even more if oil prices continue to languish. 

Related: Barclays Slashes Oil Price Forecast On Demand Shock

Unfortunately for the United States, the dynamics of the pandemic will dictate the health of the American economy. The trajectory of transmission does not inspire confidence – in New York, at least, the rate of transmission is on track to be as bad or worse than it was in Wuhan or Lombardy. Also, there are many more clusters in in the U.S. that could explode in the way that New York has over the past week. 

That suggests that the prospect of “reopening” the U.S. economy in the next two weeks is unworkable and also dangerous. That’s especially true since parts of the country have yet to actually impose strict isolation measures and the virus continues to spread. 

Absent a reduction in the rate of transmission, the economy has no chance of returning to something resembling “normal.” 

All of that is to say that while the extent of oil demand destruction continues to shatter expectations, the rather dire demand forecasts for 2020 could see even more downward revisions. 

By Nick Cunningham of Oilprice.com

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