Oil in crisis and its recovery a long road ahead!

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Leading energy market analyst Dan Dicker has famously said “Oil is a lousy investment because it isn’t an investment. It’s just a bet — and it’s a bet with a ticking time bomb attached to it”. What he has said, seems quite relevant now.

The global crude oil prices were already softening before Covid-19 began to spread its tentacles on the world and the pandemic has only accelerated the fall. The international prices have fallen by over 50 per cent in 2020 after hitting a high of USD 63.27 in 2020. Brent crude was last trading around USD 26 and WTI Crude at under USD 20 at the time this piece was being written.

Investments in oil stocks have disappointed many, especially those who traded in bulk, thinking low prices as a golden opportunity for making investment. Investors and traders are having a torrid time, with no sight of an immediate relief. The WTI Crude May Future oil contracts reached minus USD 37 a barrel, a day before the contract was to expire, seeing frantic selling by the investors. Oil future contracts are time bound and further losses may be staring investors in their eyes. Media reports suggest that the Exchange Traded Funds (ETF) are shifting investments away from the June Contracts fearing further losses.

United States Oil Fund LP – the largest oil exchange product in the country – said it would further shift its holdings into later-dated contracts, selling all of its holdings in the June contract.

Economic Impact
The economic impact of the lockdown has been tremendous on the sector putting it on a ventilator. It began with hitting the demand. With people locked down, vehicular demand of fuel has ceased globally. One of the biggest jolts have come from the global aviation sector, with operations severely curtailed.

There are media reports which suggest that the global demand for petrol and diesel was down by over 30 per cent in April which may likely improve marginally in May – a deficit still pegged around 25 per cent. In the Indian context, the demand for petrol and diesel in April was down by a whopping 60 per cent.

It is already being predicted that there will be massive shut downs seen in this sector, further mounting the unemployment situation. In US alone some 51,000 oil and natural gas workers lost their jobs in March, Reuters has said in its report quoting the Independent Petroleum Association of America.

About half of the top 60 independent companies in the US oil and energy sector could be forced into bankruptcy. The industry has already cut down operations in almost 40 per cent of the oil rigs with only over 370 in operation out of the 650. In order to save the sector, the US government has indicated that it may take equity shares in companies.

Significant production cuts have been enforced in Brazil and Canada. India’s story is no different. The domestic crude oil production during FY20 fell to an 18-year low at 32,173 Thousand Tonne (TMT) falling by almost 6 per cent.

The OPEC+ alliance has agreed to cut production by almost 10 million barrels per day or 20 per cent effective from 1 May, but the production cut may contain the economic loss for oil companies, only temporarily. Russian exports of Urals crude will also drop to a 10-year low, in May.

Moreover, a 30 per cent demand deficit for oil, has created an unprecedented storage problems for the companies. According to a report by Reuters, 85 per cent of the onshore storage was full towards the end of April. As we speak, the oil companies are incurring huge expenses on storing it. This has made investors skittish about the overall outlook of crude oil.

Around 50 million barrels go for storage in a week as per the numbers released by a media report, enough to fuel Germany, France, Italy, Spain, and the UK. The consumption in the pre-covid period was around 100 million barrels per day which has now come down to 65-70 million barrels.

The oil sector woes are likely to trickle down to other sectors too, including banks.

We are hearing news emerging from all quarters on economies contemplating on further relaxing the lockdown restrictions. It is unlikely that the oil price may see a momentum in a near or medium term, making things adverse for the sector even after the lockdown restrictions are completely lifted. The resumption of economic activity has to come in phases, but it should not take too long to get back to the full blown activity – at least at levels close to the pre-Covid period.

The world has to do a very hard balancing between saving lives and saving livelihood. There are strong voices in favour of easing restrictions, for the economic activity to resume.

India has been in lockdown since 25 March and the third phase of 14-day lockdown has been announced with further relaxations. While we a see cases rising here, government claims to have taken the doubling rate to around 11 days. There is also optimism on the likelihood of curve getting flattened by the middle of this month.

Lockdown has put a dent in the domestic demand, much to the disappointment of the governments at the states and Centre. Oil is a major revenue source for the states and Centre and governments are feeling the pinch as their money reserves start drying.

Energy sector is a critical enabler of economic growth and its performance will dictate how quickly or strongly the world economy recovers. The revival of demand is the only answer for sustenance.

As for the oil stocks, there is a lesson to be learnt – byte as much as you can swallow.

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