The ultimate supply cut enforcer: Demand destruction reaches apex

A rainy honeymoon for OPEC+ as physical despair overwhelms improvement hopes. A week removed from a historic supply deal, unprecedented physical distress has wiped out much of crude's pre-cut price rally. ICE Brent has dipped back below $30/bbl and WTI prices are under pressure. Global oil demand is now bottoming out, with our latest estimates pegging April global liquids demand at roughly 72 MMb/d, 28 MMb/d below April 2019 levels, and the lowest monthly level in at least two decades. As expected, pain is spreading from refined products to crude demand as refiners around the world slam the brakes in the face of fast-worsening margins. Traders, traditional buyers of last resort, have proved unwilling or unable to absorb the full extent of the gushing surplus of oil in the market, allowing pressure to build across forward curves, price differentials and physical benchmarks. Oil markets have entered the worst of the physical stress vortex as global inventories build massively; supply has started to respond in both managed and unmanaged ways, but markets are left to parse the modalities of the market's forceful rebalancing, with incoming market data still reflecting acute distress rather than improvement to come.

Roll tide: WTI front-month collapse on expiry underpins dire physical conditions. For a brief period every month, in the last few days of the NYMEX WTI futures trading cycle, speculative or paper futures positions start rolling over en masse to second month contracts, and as open interest for front-month contracts dwindles, markets catch a fleeting glimpse of the underlying physical market conditions. This is normally a pretty undramatic affair. But this month's roll over has put the full extent of the US physical precariousness on display.

On Monday, WTI May 2020 futures prices fell deep into negative territory.

Now it's important to clarify the unique parameters of the WTI front month price meltdown in a super-contango. Open interest in May 2020 WTI contracts has declined dramatically in recent weeks and stood just above 100,000 contracts on Friday, 20% of the size of the June 2020 open interest, reflecting that liquidity and vast majority of any speculative/paper positions had already broadly shifted further along the curve. The remaining contracts represent contracts that are set for physical delivery in May (becoming de facto cash positions). Unlike ICE Brent, the WTI contract is settled by physical delivery in Cushing at a time of dwindling spare storage capacity, leaving sellers at the mercy of extremely congested market conditions on a fast-expiring time clock.

While the contract roll and liquidity crunch that made the extreme sell-off possible also mean it is a poor representation of futures market conditions which are better reflected in June contracts , the selling frenzy around the settlement does provide a clear indication that the physical disposition of both Cushing and the US crude complex is as dire as it has ever been.

Oil markets are now faced with the challenging task of projecting the severity of short-term distress - still only partially visible in the data - and demand's uncertain recovery path against the trajectory of global supply after the OPEC+ agreement and gathering pace of shut-ins around the world. For global demand, there is finally a glimmer of light at the end of the tunnel as hospitalization rates decline in New York and countries such as Germany and New Zealand move towards cautious re-opening in the coming weeks. But that glimmer is still distant, with 95% of global gasoline demand still located in countries with major to full movement restrictions, and inventories building rapidly. With the OPEC+ cuts already set in motion, the news and data flow will likely get worse before it gets better.

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Karim Fawaz is a Director of the Financial and Capital Markets at IHS Markit.
Roger Diwan is the Vice President of Financial Services at IHS Markit.

Posted 21 April 2020

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.