It is not surprising that the outlook for front-month oil futures, especially for June, remains bleak as some market participants continue to price project shocking drop of May contract price to June contract. Recall that May WTI contract dropped below 0 on April 20 and the NYMEX decided to use the negative settlement price on April 21. This forces investors to drop one of the fundamental concepts of risk limit in WTI futures market (the loss on long futures position is no longer limited to trading equity, even in “normal” market conditions).
The story also reveals the real degree of oversupply and importance of limits of Cushing storage hub, which underlies the mechanism for settlement of WTI deliverable futures. Despite the fact that the government data indicates that the storage is only 77% full (~ 59 out of 76 million barrels), Reuters reports that the remaining storage was fully “reserved” in mid-March. The storage issues should accelerate rebalancing of the market in the near future.
At the same time, the fact of possible permanent loss of some US oil output, financial constraints limiting proper supply response to demand rebound, create an upside risk that supply rebound won’t keep pace with recovery of consumption after lockdowns are lifted. This is a favorable fact that strengthens contango in the market. However, much depends on the willingness of the US government to save the sector and jobs.
Negative prices is an unlikely threat to front-month Brent contracts, because firstly, deliveries on Brent are carried out by sea, in contrast to the “landlocked” WTI market, where Cushing oil delivery is a part of settlement mechanism on deliverable WTI futures, and secondly, Brent contracts are settled in cash, so with the approach of expiration date there should be less pressure on buyers to cover long positions.
The storage in Cushing at the current rate will be likely filled up in mid-May, with adjustment for producers which are cutting production – around the end of May. This means that pressure in front month contracts, ceteris paribus, may remain for a week or so. When the storage is full, producers will have to curb output to approximately equal the loss of demand.
OPEC held another teleconference yesterday, together with comments by IEA head Fatih Birol, market expectations are emerging that countries that joined OPEC+ pact may begin to cut production earlier than planned in May, though this looks like a late measure. The meeting of Texas Railroad Commission ended with no positive results for the market, the next meeting is scheduled for May 5. API reported an increase in stocks of 13.2M barrels, this is the fourth consecutive week when stocks are growing at more than 10M barrels per week. Cushing reserves have increased by 4.91M barrels.
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