What on earth is going on with oil prices?

You ‘can’t give it away’ – US oil prices go negative

The headlines paint a nasty picture for oil prices right now. The problem is that storage options are running out. As the world has stopped, the oil producers haven’t. They have made some cuts to production but nowhere near enough and the world is running out of places to put it.

Why not just keep oil in the ground?

Remember how Donald Trump rode to the shale producers rescue in theory? Saving jobs in Texas and other shale states.

The headlines are screaming ‘oil at lows not seen since 1999’. Turned negative. It is true. The WTI (West Texas Intermediate) futures market for the near month which is expiring tomorrow is being whacked. No one wants to take physical delivery of their oil. The costs associated with taking delivery means its more economical to sell at a negative price

Tomorrow’s headline will no doubt see something like WTI bounce from minus $40 to plus $20.

The overnight price movements are not a reflection of oil price supply and demand but the rather amusing concept of oil price speculators doing whatever they could to get rid of their May WTI Futures contracts before expiry last night. Usually there is a market for Futures contracts which are rolled into the next month but the global demand situation and the lack of storage capacity destroyed the liquidity and speculators (not producers or industry participants) had to do whatever they could to get rid of their futures contracts. Effectively paying to get rid of oil.

The alternative is taking delivery, which raises the rather amusing concept of an oil tanker being dumped at the reception of the offices of a New York Futures traders. The minus $36.98 May Futures price is not reflective of the real oil price which is still sitting at $26.13 in the UK (Brent Crude) and $21.77 in Asia (Tapis).

The oil price situation is obviously not great (for oil producers – it is great for the economy) and the oil price is getting to a point where OPEC production cuts are immaterial – it simply won’t be worth producing oil – the market will self-regulate as oil producers in the US in particular cut production.

The more important price for us is the Brent price and for consumers Tapis (that drives pump prices). How good is 97c a litre finally? I now get 1 week to the litre. If only we could drive.

Sentiment wise, it will affect our oil stocks and they will be under pressure. Lucky that BHP (ASX: BHP) extricated itself from the disastrous shale acquisition. Santos (ASX: STO) is the most leveraged but equally has recently updated the market with how much production is hedged. It currently has 9m barrels hedged, covering 30% of its remaining 2020 oil price exposure, at an average floor price of US$43 per barrel. That’s a positive. Won’t save it from a sell-off on sentiment but at some stage the sector will offer compelling value. Especially if you are pricing in Brent or Tapis.

Small US producers listed here will be in survival mode.

There are a bunch of listed US shale producers. Liquefied Natural Gas (ASX: LNG) has already had its deal to be bought out scuppered. Amongst others listed here are 88 Energy (ASX: 88E), Australis Oil & Gas (ASX: ATS), Helios Energy (ASX: HE8), Brookside Energy (ASX: BRK), Winchester Energy (ASX: WEL), Otto Energy (ASX: OEL), and Byron Energy (ASX: BYE).

Baker Hughes’ data shows the US oil drilling rig count has fallen to 438, representing the sharpest contraction since 2010. Active rigs dropped by two thirds last week. One year ago 825 rigs were active.

US energy analysts say that 70 US oil and gas companies could be in trouble and unlikely to be able to pay interest payments at even US$30 a barrel. The same analyst said that US$250bn of debt is at risk in 2020-21 with US$70bn of debt in 2020 and US$177bn in 2021.

At some point the world’s economy will get back in action, at some point oil storage will peak, at some point the oil price will bottom. The headlines today are creating the low point not the high. We will look back on this period as a buying opportunity one day.

We are still holding our oil stocks (we’ve halved them actually but will look to re-buy). The sector is down 46.9%. It’s not denial. It’s a judgement on where sentiment is. You have to get ahead of the headlines, not respond to them.

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I’m Marcus Padley, the author of the Marcus Today stock market newsletter. To sign up for our free 14-day trial and access our ASX share research and commentary, please click here. There’s no obligation and no credit card required. Just come in and take a look.

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