The world is changing fast and to keep up you need local knowledge with global context.
Earlier this week, oil prices plunged into negative terrain. This was an unprecedented move with South African asset management experts noting that they had never seen this development in their careers. In a clear sign that global Covid-19 lockdowns have eliminated demand for oil, pollution levels from oil-related emissions have been clearing to reveal Himalayan mountain tops and ocean life in Italian tourism hotspot Venice. But there’s more to the oil price plunge than most of the world’s passenger vehicles standing idle, with the commodity subject to complex contracts and supply factors, including international wrangling between oil-producers like Saudi Arabia, Russia and the US. In this highly informative podcast, Justus van der Spuy, a global expert on energy markets, demystifies the oil price collapse. He also discusses, with BizNews editor-in-chief Alec Hogg, why energy and chemicals company Sasol, which has taken a severe battering on the JSE in recent months, was relatively unaffected by the sharpest oil price shock in living memory. – Jackie Cameron
Justus van der Spuy is based in London. Great to be catching up with you today because of your knowledge and insights into the oil market, which the rest of us are completely confused about. How long have you been exposed to the sector?
I have been in the energy markets for the past 30 years. A lifetime.
Have you seen anything like we’ve witnessed in the past week?
No. What we’ve seen happening and I would hasten to add what is happening to WTI is unique, if that’s what you are referring to, but also relatively isolated. Have we seen vast movements in the price of oil in the past 30 years. Absolutely. We’ve seen events that drive volatility of this nature before, but this is somewhat unique and somewhat unusual because of the Covid-19 situation.
WTI – What’s that stand for.
So West Texas Intermediate – basically a contract with reference to most USA and other international crudes that are traded. WTI is priced at Cushing in Oklahoma, which is a conglomeration and storage point for crude oil that is produced in the US, in particular WTI for the immediate delivery with or very prompt delivery in May which we’ve seen the unprecedented negative pricing that you might be referring to.
Which the media’s been focusing its attention on here in South Africa. We price through Brent crude. What’s the difference between that and WTI?
Brent crude is again a reflection of North Sea oil production. Nowadays a combination of several North Sea oils that are being produced. I would say probably still the majority of internationally traded crude is traded with reference to Brent. There is another crude oil marker Dubai or Oman which a lot of the refineries in Asia would price with reference to, but Brent is also used for sales into the US or sales to Asia and of course South Africa would purchase a lot of its oil on a Brent related formula.
Is there any difference in the two prices at the moment?
Yes the WTI until a few years ago, before the US emitted the export of US produced molecules, was very much a local affair. So the pricing of crudes produced within the US or certainly in Canada and the US, price was referencing WTI. In the past two or three years we’ve seen this huge change to the oil markets in which U.S. molecules of oil have headed for export markets. WTI is now a reference also internationally traded crude.
So what’s the story with a -$14 a barrel. South Africans are saying I’m gonna go to the petrol station, fill my car up with petrol and they’re going to give me money to leave.
Yeah well you know dream on. I think it was not -$13, it was -$37 at one point or -$40 was achieved, but this is a little bit of a unique situation where in the United States the WTI futures contract converges with physical delivery at Cushing in Oklahoma and the May contract for WTI was due to expire today or yesterday. A few of the players who were not in the physical market, held on a little too long and didn’t unwind the contract what might have been prudent, particularly in this market a few days earlier or a week earlier and ultimately the only way they could get out of these contracts was to pay somebody to take it off their hands. So it does reflect that oil production has continued to pace in the US although it’s lower storage is filling up and of course in the immediate future i.e. for May delivery has become quite acute but once this technical issue was resolved the contract bounced back into positive territory so there was – between the day in which the minus -37 was hit – and the following day – there was a $48 reversal to territory of plus $10 or $11. Of course still low by historical standards because I wouldn’t say we are heading for long term negative crude oil prices because ultimately people who produce the stuff are not going to continue to pay people to take this off their hands.
Thanks for explaining that Justus. That the whole Covid-19 impact on the global economy is being reflected no doubt in the oil price as you’ve just explained it’s low by historical standards. Is this just because the world is locked down and when it comes back to normality oil will rise again. Or is it a reflection that people are concerned about the global economy actually bouncing back anytime soon.
Well firstly Covid-19 is the major demand destruction factor. We’ve seen unprecedented demand destruction. There was, as you will note from OPEC or OPEC Plus meetings in the months prior, there has been concern about marginally too much oil production hitting the markets and attempts were made by the Saudis and the Russians primarily to try and curtail production to some extent and hold the markets in balance. However, between February to April, the biggest factor was a coordinated shutdown across most of the globe’s economies. You’ve seen gasoline demand growing by 40% to 50% and that has to go somewhere. Crude production or inputs into refineries down by 20% and that is already telling you that if crude being absorbed into refineries is down by less than the demand on the other side, all of that product and crude has to go somewhere.
I know you’re an international player and perhaps don’t look at South Africa as often as you might have, but we all watch Sasol here and their share price hasn’t really moved despite the oil price having fallen so dramatically. Let’s put it differently. It hasn’t moved in the in the last month or so. It’s come down a long way from where it was a few months before it is. Why would that be?
Well Sasol share price has already in the period prior to this taken somewhat of a hammering. So one has to factor that in as well. Perhaps my colleague Enrico might give us a more nuanced appraisal of what’s happening to the Sasol share price but I would say it has already come down a long way. Sasol as far as I know, is not running its conventional refinery in South Africa at the moment and perhaps like many other refineries, are avoiding the losses by continuing production of products that for which there is no demand. The Rand which has depreciated at the same time, acts as a kind of a hedge, and that it’s offset by the destruction of the oil price in many ways.
Explain that hedging because I think there was a statement from Sasol a couple of weeks ago which lifted the price, saying that it had hedged its production or hedged its sales at around $50 a barrel somewhere along there. How does that all work because presumably the fact that Sasol has hedged, as you’ve just mentioned some of its production, if not all, means that even if you got negative oil prices, it’s not going to be that impacted unless this continues indefinitely.
Well two things. If Sasol has hedged their production at $50 then they’re spared the immediacy of the pain that is being felt around the globe. But if you also look at forward oil prices, if people focus on a -$37, which I hasten to add is an aberration, unique to Cushing in the US, it’s a technical ending of a futures contract issue more than anything else. Prices are low but if you look in the forward oil markets, they are factoring in that at some stage the world can’t afford to remain in a Covid-19 complete lock-down. There will have to be some easing up, demand will return and no doubt for Sasol as well. So apart from being, in hindsight, quite wise in executing these hedges, which means that if their production is worth $10 or $15 they still achieve 50. So that of course helps them a lot. But if you look at the forward market prices for oil then you’ll see for example Brent, which was priced last night for June delivery at around $20 a barrel. July would be $24, August $27. So you can see that the market is anticipating in the shape of the forward oil prices that there will be some recovery at some point in time. And that’s really interesting for Sasol as well.
That’s really interesting for amateurs or people who are watching these market. In essence what you’re telling us now, is that those people who are putting bets on what’s going to happen to the post-Soviet economy are saying it’s going to improve significantly in July, August and perhaps into the future thereafter. So they’re giving us a timeline of the end of the lockdown.
Well that shape of the oil price curve continues. You would find for example with Brent, if you look at December 2021, you’re looking at pricing of around $39 being achieved. So if you are a producer of oil, say Norway or Mexico and I mentioned these two countries that have always been active hedgers of oil. If they can hedge the forward production of oil as Sasol did, it’s production of materials, if they can achieve $38, that’s not a good price by historical standards but in the face of the current prices there might be an element of prudence involved in them selling forward some of their future oil production, $38, $39 a barrel. Equally buyers of oil would see that as an opportunity relative to the value of oil products which they would be producing at the time. So there’s a balance of supply and demand fundamental players and also financial and speculative players, and people who wish to invest in oil might still see $38 a barrel as a decent buy. So a variety of players determine the shape of the forward curve so the $38 sounds dramatically different to the $10 or $20 you see today.
And it also tells us that this too shall pass.
It’s difficult to predict what happens in the oil markets, it’s simply saying there has to be a return to normality by the time you get there, in July this year or in July next year the oil market will then look very different to what the shape of the oil curve is telling you at the moment. So what will OPEC’s meetings of the future determine in terms of demand or production constraint. The other big player is the US, in terms oil pricing the US is the biggest new variable that I’ve seen in the past 30 years of my involvement in the business, and while the crude oil types are very different to what it produced in the Middle East, it’s nevertheless changed the shape of oil trading and the flows of oil. Will a lot of the shale oil producers go bust in the current pricing environment, will a lot of the Canadian oil producers go bust, and what will the outcome of that be in terms of re-emergence of production as some of these assets get scooped up by some of the stronger players in those markets.
My prediction is that, if we have to make one, there has to be some return to normality but it’s going to take a while because one thing we haven’t addressed is oil in storage, with the unprecedented demand destruction which Covid-19 has brought because oil has to go somewhere. And so oil storage facilities globally are filling up. In South Africa, in Saldanha Bay which will no doubt be full at around 42 million barrels. There are other storage facilities so it’s maybe 50 million barrels in South Africa. In the U.S. you have oil inventories hitting over 500 million barrels for crude oil, almost 300 million barrels for gasoline. So to dissipate that stored inventory – globally – and then you talk about Singapore you talk about strategic petroleum reserves in India, China, Japan and everywhere. People are also seeing this as an opportunity to acquire oil inventory at lower prices. So it’s going to take a while to absorb the oil that has been put into storage. On the other hand we’ve seen the price of freight for oil increase. Where you find that oil prices are low, shipping prices are quite the reverse because the 2 million barrels shipped is a form of moveable storage. So people with nowhere to go are now storing oil in ships and therefore the cost of shipping has increased dramatically. So current pricing of shipping is dramatically higher than the future price of shipping. So quite the reverse of the oil market. So adding all that up together, you’re going to have to have quite a return of demand to absorb oil. I’m not an economist but if you look at what’s happening to small businesses and various economies, there isn’t going to be a quick bounce back on economies and therefore you’d also expect oil demand to to come back at a slower pace. Therefore all this inventory is going to take a while to absorb.
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