What a difference a year makes! It might sound like a cliché, but the oil market that was turned on its head last April by a confluence of unexpected Black Swan events is trending higher alongside a rosy outlook for the U.S. economy. Along the way, the market structure for domestic and global crude oil turned from a yawning contango to backwardation, while the consortium of oil producers including the Organization of Petroleum Exporting Countries, Russia and nine additional countries, also known as OPEC+ are unwinding production cuts, which have been in place for more than four years.
On April 20, 2020 the price of West Texas Intermediate crude oil on the New York Mercantile Exchange turned negative and settled the historic day at a minus $37.63 bbl as panicked sellers were forced to dump their holdings of the expiring May 2020 contract at any cost. Stunned market observers had a difficult time wrapping their heads around the idea of paying someone to take your oil. Was oil trading breaking down in the jaws of a pandemic? Three events occurred leading to the great oil crash of April 2020 — a market share war between Saudi Arabia and Russia; a once in a century pandemic; and record-high U.S. oil inventories. The improbable events, feeding upon themselves, occurred in dizzying quick succession.
Perhaps more stunning is the remarkable turnaround that has taken place in the oil market since then. Today, oil futures are comfortably trading in the $60s bbl, some of the largest economies around the world are gradually reopening, propelled by the fast deployment of COVID-19 vaccines and, in wealthier countries that are part of the Organization for Economic Cooperation and Development, generous government stimulus has had a positive impact on economic growth.
As global oil demand is picking up pace, concerns about securing oil storage worldwide have all but evaporated, with commercial inventories across the OECD already falling to their five-year average from an all-time peak at 249 million bbl in July 2020, according to the International Energy Agency.
While still not out of the woods, the remarkable turnaround over the last twelve months warrants another look at the oil market crisis during a tumultuous period for the industry during the first half of 2020.
Saudi Arabia and Russia
A few weeks before the U.S. crude benchmark contract on the NYMEX briefly became worthless, Saudi Arabia and Russia not only failed to agree on output cuts during the OPEC+ meeting but decided to unleash millions of barrels of additional crude oil onto the market. All this while global oil demand was plummeting, with consumption crushed by the COVID-19 pandemic.
Both parties, unlikely partners married out of practicality with the goal to capture market share from U.S. shale producers, greatly mismanaged their positions. Russia clearly underestimated the collapse in fuel consumption following the first wave of shutdowns late in the first quarter 2020. Global oil demand plummeted as much as 35 million bpd in what is now referred to as “Black April” from a record-high 100 million bpd just two months prior.
A heated Crown Prince Mohammed Bin Salman allowed his emotions to dictate Saudi policy while ordering an increase in the kingdom’s crude production, the opposite of what he was counseling Moscow on, triggering a five-week war for market share. By refusing to preemptively agree to production cuts, Russia ensured all OPEC+ members were facing a very real collapse by a market their economies depended upon.
U.S. President Donald Trump brokered a ceasefire between the crown prince and Vladimir Putin, with OPEC+ on April 12, 2020 agreeing to reduce crude oil production by 9.8 million bpd, about 10% of global oil production, with participants involved in the historic agreement cutting their output by 23%.
At the time, few analysts expected the alliance forged by the common goal to save the market from imminent collapse would hold up for as long as it did. Currently, Russia and Saudi Arabia continue to withhold about 60% of the production they decided to cut a year ago.
Bolstered by their success in moving the global oil market closer to balance, and with it pushing crude prices back above $60 bbl, OPEC’s influence is stronger today than it had been prior to the pandemic. At their last meeting, inauspiciously held on April Fool’s Day, OPEC+ agreed to gradually restore a portion of their production over the next three months, reflecting a more optimistic outlook for the global economy. OPEC+ meets again on April 28.
When the global pandemic first struck it was natural to fear that the world economy would slide into a deep recession if not depression. Economic controls implemented during the Spring 2020 lockdowns led to widespread shutdowns of schools and what were deemed nonessential businesses, sapping demand dry as life slipped further from normalcy. Consider that on this day a year ago gasoline consumption in the United States — the world’s largest oil consumer — was hovering just above a record low of 5.065 million bpd.
Locking down local and state economies proved less effective at curbing economic activity and, as such, demand for petroleum products. The California lockdown enacted by Governor Gavin Newsom in December 2020 remained largely on paper, with Los Angeles highways jammed with traffic and shoppers flocking to malls for last-minute holiday shopping. Public fatigue and eventual noncompliance with politically toxic quarantines along with federal largesse through direct stimulus payments spurred a faster-than-expected recovery in U.S. fuel consumption.
By August 2020, gasoline supplied to the U.S. market reached the pre-pandemic level of 8.865 million bpd despite parts of the economy remaining shut and new infections surging. Governments in rich OECD countries enacted a fiery policy mix to boost economic activity which did not require citizens to reengage in the larger economy. The massive payout schemes, including personalized stimulus checks, generous unemployment benefits, loan assistance for businesses and mortgage forbearance not only kept the economy out of recession, but fueled growth. Since the beginning of the pandemic, the U.S. government has spent almost $6 trillion compared with $700 billion authorized in the aftermath of the Great Financial Crisis 2008. The result was near unthinkable a year ago.
U.S. households are estimated to have stashed away $3 trillion in “excess savings” during the first nine months of the pandemic — a tenth of annual consumer spending. An OECD outlook now expects the United States to be larger by the end of 2022 than it would have been if the pandemic never happened.
The main driver of the ongoing recovery is undeniably the rapid development and distribution of COVID-19 vaccines, with hundred of millions of doses already produced and administered in less than a year’s time. Ever since Pfizer and German partner BioNtech announced their experimental vaccine using MRA-technology was 95% effective in preventing severe cases of the disease, oil futures began their nearly uninterrupted five-month long uptrend.
The U.S. vaccination campaign accelerated around mid-January from a little under 1 million doses to the current 3.5 million doses pace administrated each day. The country continues to move closer to “herd immunity,” with over 200 million doses having been administrated so far.
The public-private partnership through Operation Warp Speed was instrumental in this effort despite, at times, halting progress. The single dose Johnson & Johnson and AstraZeneca vaccines, seen critical for the developing nations to reach their immunization targets, have since been halted amid concern over rare but severe blood clots developed by some patients. The unwelcomed development comes at a time when much of the world is still battling a resurgent virus and new variants. The European Union, India, and Brazil, all major oil-consuming economies, have recently announced new quarantine orders to halt the viral spread, erasing a chunk of potential demand growth.
Despite weaker-than-expected data in the first quarter, the International Energy Agency expects that global demand will recover to just 3% below its pre-crisis level in the second half of the year as vaccines become more available and economies continue to reopen.
A year on from what the IEA called “Black April”, one of the darkest months ever for world oil markets, fundamentals look decidedly stronger.