If you’re an entrepreneurial type, you were probably lying in bed last night trying to figure out how you could convince your neighbors to rent you their back yard swimming pools to take delivery off 5000 barrels of June at -40 and sell them back for 30 plus when the dust settles. But all joking aside, global markets are struggling mightily with a temporary but overwhelming demand drop due to the coronavirus pandemic.
The massive demand drop is getting aggravated by the build in the paper market via USO ETF, which is compounding delivery risk into June after the cataclysm and startling drop into deep negative territory on the May settlement date. Not only could the June WTI fall prey to storage infrastructure saturation but also a massive execution risk as everyone knows where that position sits now. And as market makers are prone to do, they’ll show the USO all the mercy of a Greek tragedy at roll time.
In this type of situation, traders could move along the curve and pay the contango early to avoid June settlement risk by selling June and buying a mix of Jul-Aug-Sept, which will put pressure on the first month. In other words, long-only funds open interest could shift more distinctly along the curve to mitigate immediate settlement risk as WTI storage is most probably leased into July and likely a good chunk of September (as we suggested on yesterday's Morning Note, some of that happened overnight, looking at open interest along the curve). But any way you slice the delivery pie, ominous storm clouds are going to envelop the Cushing WTI storage infrastructure as June delivery risk looms ominously on the horizon.
Oil prices lifted off the mat after June delivery tumbled as much as 43% as the fear of delivery risk compounded the storage saturation scenario, but profit-taking set in after the OPEC+ alliance reportedly held an unscheduled conference call overnight. But given they’re as shell shocked as the industry, they haven't come up with any new policy yet to tame the 30 million – soon to be 35 million – barrel per day demand drop beast. But they better make haste as US oil is on the verge of resembling the candle industry when Edison invented the light bulb. Indeed the probable shift to more green energy post Covid-19 will compound matters to an industry in need of a quick fix.
It doesn't matter how many deals President Trump cuts or how much the Texas Railroad Commission compensates US shale; oil production will fall because it has to fall. US shale producers are already shutting down, laying off workers and pretty soon will be filing for bankruptcy. There’s no production deal that will change that.
The only thing that saves the shale industry is the world economy opening up soon or a virus cure. The super contango in the WTI curve beyond the front-month contract suggests that near-term downward pressure will remain static until the lifting of lockdowns in the US triggers more robust demand, or when domestic production declines more sharply – and it may be too late for that as the removal of travel alerts and the opening of border crossing could still be a ways off. Not to mention, there’s no guaranteeing people will be jumping on planes and trains or back into their automobiles any time soon.
It's hump day, and not only are oil storage tanks reaching the saturation point, but so have oil markets.
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