What led to oil market crash and how does it impact India?
A major reason for the drop in demand is that most airlines are running minimum operations, estimating a 45 percent drop in jet fuel demand by the second quarter.
April 20, 2020, was a historical day when one of the most desired commodities - that has triggered wars - entered into a negative price zone.
The question is what led to this negative price and does this have any relevance to physical markets and consumer countries like India?
First, we need to understand the reasons that led to the possibility of a negative price for oil.
Physical oil market
1. If we look at the physical market, there is a fall in demand for oil by 20 million barrels per day due to global shutdown. A major factor of demand drop is that most airlines are running minimum operations, estimating a 45 percent drop in jet fuel demand by the second quarter.
2. OPEC+ involving G20 countries agreed on cutting off 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 a very high speed that led to force majeure being declared by global and Indian refineries.
US oil futures market
1. On April 15, 2020, CME (largest commodity trading exchange) issued an advisory that certain NYMEX futures could trade at negative or zero prices and also settle at negative or zero prices due to the current oil market environment.
2. On April 16, the US Commodity Funds that manages the United States Oil Fund (largest oil ETF), with an asset size of $3.9 billion, says it will shift to the later date future (two-month future) from 100 percent near month future (1-month future). A 20 percent of assets were to shift on April 17, 2020, and rest in foreseeable future.
3. WTI futures delivery is taken at Cushing, Oklahoma, where the capacity was filling up fast. It was at 77 percent capacity as of April 17.
Result of events on April 20
As per the settlement cycle, May futures were to expire on April 21 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 the changes, most of liquidity of the May future evaporated post April 17 and there were a large number of contracts outstanding.
This resulted in heavy liquidation of May Future on April 20, 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 percent on April 20 but traded at around $21/bbl as seen below.
Due to the shift in asset allocation to June futures, USO saw a drop of 10 percent in NAV as compared to a drop of 300 percent in WTI May futures.
What to expect now?
Though WTI May futures expire on April 21, there will still be volatility in prices. But this does not mean that June futures do not have a scope of a 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 second half of May even if all the countries speed up the process.
3. Investors of USO have seen a large destruction of wealth in the last two days, there will be heavy redemptions in the ETF that will impact future outstanding contracts the next day. USO accounts for 30 percent of outstanding contracts of WTI June Futures.
How does it impact India?
Though it is obvious that India will benefit from such a situation, given that it is second-biggest oil consumer but the current environment of a lockdown does not help take the advantage even if we reopen soon.
The current import of oil has reduced by almost 50 percent in volume to 2.3 mn bbl/day from 4.2 mn bbl/day. This will take a long time to normalise for the benefit to reflect.
Indian Oil Corporation along with other major refineries have declared force majeure for some oil purchase contracts.
Fuel demand was 50 percent down in the first two weeks of April, led by 61 percent fall in petrol, 64 percent fall in diesel and 94 percent 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.
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 crude prices to remain low with further downside risk as the demand side will take a long time to recover. But we disagree that India will not benefit much from these prices as the import volumes are also impacted by a large portion.
A major reason for the drop in demand is that most airlines are running minimum operations, estimating a 45 percent drop in jet fuel demand by the second quarter.
What led to oil market crash and how does it impact India?
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Register for 2 days Trial - Whatsapp - 9841986753April 20, 2020, was a historical day when one of the most desired commodities - that has triggered wars - entered into a negative price zone.
The question is what led to this negative price and does this have any relevance to physical markets and consumer countries like India?
First, we need to understand the reasons that led to the possibility of a negative price for oil.
Physical oil market
1. If we look at the physical market, there is a fall in demand for oil by 20 million barrels per day due to global shutdown. A major factor of demand drop is that most airlines are running minimum operations, estimating a 45 percent drop in jet fuel demand by the second quarter.
2. OPEC+ involving G20 countries agreed on cutting off 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 a very high speed that led to force majeure being declared by global and Indian refineries.
US oil futures market
1. On April 15, 2020, CME (largest commodity trading exchange) issued an advisory that certain NYMEX futures could trade at negative or zero prices and also settle at negative or zero prices due to the current oil market environment.
2. On April 16, the US Commodity Funds that manages the United States Oil Fund (largest oil ETF), with an asset size of $3.9 billion, says it will shift to the later date future (two-month future) from 100 percent near month future (1-month future). A 20 percent of assets were to shift on April 17, 2020, and rest in foreseeable future.
3. WTI futures delivery is taken at Cushing, Oklahoma, where the capacity was filling up fast. It was at 77 percent capacity as of April 17.
Result of events on April 20
As per the settlement cycle, May futures were to expire on April 21 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 the changes, most of liquidity of the May future evaporated post April 17 and there were a large number of contracts outstanding.
This resulted in heavy liquidation of May Future on April 20, 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 percent on April 20 but traded at around $21/bbl as seen below.
Due to the shift in asset allocation to June futures, USO saw a drop of 10 percent in NAV as compared to a drop of 300 percent in WTI May futures.
What to expect now?
Though WTI May futures expire on April 21, there will still be volatility in prices. But this does not mean that June futures do not have a scope of a 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 second half of May even if all the countries speed up the process.
3. Investors of USO have seen a large destruction of wealth in the last two days, there will be heavy redemptions in the ETF that will impact future outstanding contracts the next day. USO accounts for 30 percent of outstanding contracts of WTI June Futures.
How does it impact India?
Though it is obvious that India will benefit from such a situation, given that it is second-biggest oil consumer but the current environment of a lockdown does not help take the advantage even if we reopen soon.
The current import of oil has reduced by almost 50 percent in volume to 2.3 mn bbl/day from 4.2 mn bbl/day. This will take a long time to normalise for the benefit to reflect.
Indian Oil Corporation along with other major refineries have declared force majeure for some oil purchase contracts.
Fuel demand was 50 percent down in the first two weeks of April, led by 61 percent fall in petrol, 64 percent fall in diesel and 94 percent 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.
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 crude prices to remain low with further downside risk as the demand side will take a long time to recover. But we disagree that India will not benefit much from these prices as the import volumes are also impacted by a large portion.
