US stocks are rising, as fears seem to be easing over a possible step backward in the war against coronavirus. Brent crude suggests the global oil market may be tightening. The market is seeing better demand ,as Chinese oil consumption has exceeded previous levels, and the increase in demand for oil in economies that are opening up is becoming apparent. While we still have a long way to the go, the OPEC+ production cuts are helping the market move to balance very quickly in what could be one of the fastest adjustments from an oil price crash ever.
The backwardation in Brent crude futures shows the physical oil market in Europe is exceptionally tight. Bloomberg News reports that, “Two months ago, every trader wanted to sell cargoes, and none were keen to buy. Now, the window has transformed into a bull market, where bids outnumber offers 10 to one, and prices are surging.”
“In China, oil consumption is now back to pre-pandemic levels, according to official data. It’s still down in countries like Italy and Spain, which were badly affected by the coronavirus, but rapidly recovering in others, including India, Japan, France, and Germany. Global demand fell as much as 30% in late March and early April when governments locked down entire countries. The scale of the rebound is still hotly debated, but most say consumption is now 10% to 15% below normal levels," according to Bloomberg.
Bloomberg also reports that: “The number of commercial flights has increased to 50,000 for the first time since the coronavirus crisis grounded the aviation industry — that’s double the low of early April, but still down ~55% from pre-crisis levels. Still, it is a flight in the right direction.
Our take is that the market is showing signs of moving into balance. Historic cuts in cap-ex, and the OPEC+ reductions are erasing current and future oil production from the market. Shale production has been set back years because of the recent price crash. The FT reports that:
“U.S shale companies could be forced to write down at least $300bn of their assets in the second quarter, as operators begin to account for the oil-price collapse on their balance sheets, according to a new study. The massive impairments — about half the net value of the companies’ property, plant, and equipment — would increase the sector’s leverage from 40 percent to 54 percent, triggering insolvencies and restructuring, says the study by Deloitte."
“As Covid-19 impacts amplify pressures on shale companies through 2020, a wave of impairments may prompt the deepest consolidation the industry has ever seen over the next six to 12 months,” said Duan Dickson, vice-chairman of Deloitte’s US oil and gas business. The write-downs, based on an oil price of $35 a barrel, would be another blow to a sector that has been hammered by the worst oil-price crash in decades. US crude output has plummeted as operators shut wells, idle rigs, and sack oilfield workers.
Rystad Energy, a consultancy, calculated that shale producers’ impairments in the first quarter were about $38bn. By the end of May, 18 exploration and production companies had declared bankruptcy this year, according to Haynes and Boone, a law firm. Denver-based Extraction Oil & Gas recently joined the list. Chesapeake Energy (NYSE:CHK), an early shale pioneer, is likely to follow soon.
The FT says:
“The sector’s vulnerability stems from the fast rate at which shale production declines, meaning new wells must always be drilled to replace fast-falling output at other ones. Soaring output in recent years depended on Wall Street’s willingness to keep funding that treadmill with new capital. But investors have now soured on shale. Wall Street is unlikely to fund a further recovery or pay for the consolidation analysts say the sector needs."
My take is that we are headed into a tightening market. Those who chose to fight the economic stimulus from the Fed and global central banks will pay the price.