By Irina Slav
It was going to be a reasonably good year for oil. OPEC+ would continue to keep a lid on production to keep prices above dangerous levels, and U.S. shale would continue to expand. But a series of events–some predictable and some not-so-predictable would change the trajectory of the global oil market.
Russia quit the cuts. The coronavirus epidemic that had paralyzed China signaled it had bigger plans, ones that involved the whole planet. The result: what started as a reasonably good year turned into a nightmare.
The oil industry is reeling from this nightmare, but unfortunately, there is no waking up from it. Oil producers are selling their crude at discounts to even current depressed benchmarks, desperate to find buyers, according to a new Bloomberg report. The price pain is universal, stretching from Russia to Alaska and from Europe to Australia.
At the same time, oil storage tanks across the world are filling up, sparking fears that we will soon reach capacity. When this happens, current prices will seem high by comparison. There is also a looming shortage of tankers as traders charter VLCCs to store crude offshore. The cherry on top of this oil horror cake is the uncertainty about a global production cut deal.
Someone should definitely make a movie about it.
Bloomberg reported this week, quoting unnamed traders, that Russia’s Sokol blend was selling at a discount of some $8 per barrel to the Dubai benchmark, which traded at about $33-34 on Monday and Tuesday. This, according to the report, was a stunning $11 per barrel less than the last Sokol deal. Even worse, Australia’s Varanus, according to the traders, traded at a discount of $13-14 per barrel to dated Brent, which this week recovered to around $30 a barrel. That’s down from a premium of 50 percent to Brent for the last Varanus cargo.
The discounts tell a gloomy story: there is a lot of oil and few buyers. It’s a story that has become pretty familiar over the last few weeks. The coronavirus outbreak crippled demand–first in Asia and then in Europe, North America, and anywhere else people are being advised to stay at home to prevent the further spread of the disease. So all the oil that cannot be sold, discounts or not, is being sent into storage.
Earlier this year, data analytics company OilX calculated that there were about 650 million barrels of crude in storage onshore and another 100 million barrels in tankers offshore.
But this was in mid-March. Since then, demand is thought to have fallen further thanks to lockdowns, more flight groundings, and travel restrictions.
Now, another analytics company, Signal, who focuses on the shipping industry, has calculated that as many as 440 Very Large Crude Carriers may be required for floating storage, meaning they would be unavailable for normal operations. This monstrous number of VLCCs would be needed in the event of an oil Black Swan, Signal’s analysts said. Such an event would entail oil overproduction of 20 percent over demand that would result in 880 million barrels needing storage space.
The firm also made calculations for low- and mid-case scenarios, in which oil production would exceed demand by 10 percent and 15 percent, respectively. In the low-case scenario, there would be some 115 million barrels in need of storage, which would mean 57.5 VLCCs. In the mid-case scenario, the extra barrels needing storage would be 497 million, which would require 249 VLCCs.
Right now, the world is in the low-case scenario, according to Signal. This is good news given the reports about onshore tanks filling up, with at least one major hub—Saldanha Bay in South Africa—almost full now. Space is quite literally running out.
The situation may progress from a low-case scenario to a mid-case scenario if OPEC and the rest of the oil world fail to agree on a deal. It will be a different deal: this time everyone will have to cut, which may make reaching an agreement on quotas more difficult. On the other hand, everyone is suffering now, which could make reaching an agreement easier.
The problem is, even a global deal may not be enough for the physical market. A deal could prop up prices, but it won’t magically revive demand, which, according to the latest reports, may have fallen by as much as 30 percent or 30 million bpd already. There has been talk of cuts totaling 10 million bpd, with U.S. President Trump mentioning a range of 10 to 15 million bpd. But that’s just talk.
There is a glimmer of light on the horizon, however. China is tentatively returning to normal. Refiners who had to reduce their run rates dramatically during the lockdown are now once again buying oil. It is way too early to say how long China’s full recovery will take, but the renewed interest of Chinese buyers in oil is certainly cause for hope that the nightmare will end eventually.