Oil market: Second phase of downcycle starts
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 21 April 2020, 9:05 AM
- Sectors Covered:
- Mining, Energy
WTI (key US oil price) dipped into negative territory last night, for the first time ever.
The active contract for May for WTI collapsed to around -US$37 (yes negative!) at its overnight lows.
In our view this marks the emergence of the second phase of the downcycle in oil, with tangible signs of storage limitations emerging.
The third phase will be supply destruction as some fields/companies are forced to close due to physical transportation/storage limitations or corporate financial stress.
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So why did May fall so hard?
As the expiry of the May contract approaches, buyers are panicking that they face having to take physical delivery of the barrels in a market where there is little to no available storage.
The June contract is still around US$20/bbl, with a contango thereafter.
I expect June prices to continue to drift lower as it approaches.
The Brent price is also in decline, although a much healthier US$26/bbl, with seaborne supply less constrained.
Almost there but still a bit too early
We expect the panic selling to continue in oil futures markets and ETF’s and for it extend into June. We have been waiting for this kind of oil price volatility (waiting for it to hit rock bottom) so we can gain conviction on our buy ideas, and it looks like it is quickly approaching.
This is all bullish for the longer term outlook for oil, as the carnage dealt to the supply chain will see the global industry unable to keep pace with an eventual demand recovery.
We are likely to see some bargains appear in the sector as the market increasingly prices in less and less.
But at this stage it is still a little too early to turn positive and as a result we still remain cautious.
Fortunately our preferred sector picks (Morgans clients only) are in good financial shape to weather the current price environment and we expect will recover in share price when an inevitable recovery.
Morgans clients can login to view further detailed analysis on the oil sector in our Research section. Alternatively, please contact your Morgans adviser or nearest Morgans office for access.
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