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  • Writer's pictureDragostin Kozhuharov

What is happening with Oil?

We are sure that is what everyone is asking themselves at this moment, so we decided to try and explain.

Since governments started to impose lockdowns due to Covid 19, Oil entered what is called a contango market. This essentially means that the futures price of a commodity is higher than the current spot price. What this implies is oversupply of the market - this could be either due to too much production, lower demand or both. Essentially a contango market gives an incentive to physical traders to buy oil now and store it, to sell at a higher price later.

Now as this happened to the oil market, OPEC+ and mainly Russia and Saudi Arabia were expected to agree on a supply cut in order to balance the market. After a disagreement on the cut, the two major producers entered a market share war, where both countries actually pledged to increase supply and compete for market share amid a market with low demand. This ignited a selloff in oil where WTI reached 20$ per barrel.

This raises a question - what market were they fighting for? Due to the supply vs demand dynamics, there really wasn't anything to fight for.

Surprise, surprise US President Donald Trump, who many times before criticized OPEC for inflating oil prices and said that he wants a low price for oil so Americans can have cheap gasoline, entered the stage with a tweet that he is trying to get everyone to agree on a supply cut of 10-15million barrels per day. Oil prices jumped and WTI traded above 29 briefly. An OPEC+ meeting was announced, but then was postponed by 4 days.

During the day of the virtual meeting initial reports came out that the cut would be 20million barrels. Oil traded to the upside again as this was bigger than expected. Then however the real figure of 10million barrels per day finally was confirmed and disappointed markets just before Easter. Furthermore a G20 meeting and continuous talks during the weekend were made to try and convince Mexico to participate in the deal. Finally the deal was agreed but it was for just under 10million barrels.

Why were the Mexicans resisting the deal? Surely it's better for them for oil prices to be high as a big producer. Well here comes the explanation - Mexico hedges their physical oil production. As such they had secured prices for their output and therefore they weren't exposed to this downward movement in oil prices.

Now you are probably thinking - there was a record deal to cut supply, surely this would be positive for the price. Well, when the demand has declined by as much as 30million barrels, a 10 million barrel cut doesn't do much. And markets have showed it.

WTI May futures traded as low as 10.775$ per barrel earlier today. Remember, how I mentioned that physical traders are inclined to store oil during contango. The WTI price is reflecting that the US is running out of storage to store oil. If the inventories in Cushing become completely full, the price could continue to fall. Granted this could also make some American producers curb production because it's not making economic sense for them to keep going.

What's the view going forward? - If the economies that were shut down due to Covid 19, get restarted and demand starts to pick up, we could witness a strong recovery in Oil with WTI above 30$ per barrel. As with everything else Covid 19 is the key, but the economic shock caused by it, could actually affect demand for a longer time than expected.

Let us know your views on the oil market.

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