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WTI crashes lower, yet storage issues could leave further to run

US crude is likely to continue its underperformance as the filling up of storage facilities leave it with nowhere to go.

Oil markets have grabbed the headlines throughout the course of this coronavirus crisis, with the battle for supremacy between Saudi Arabia, Russia, and the US ensuring that energy volatility kept up with moves elsewhere.

Many will have seen the Russian involvement in the recent spat with Saudi Arabia as a ploy to hit US producers, and while there has been an agreement to cut output by 9.7 million barrels per day (bpd), it looks to be the US which is being hurt the most in this crude crash. The crux of this predicament is that there is a huge oversupply issue which needs to be resolved, with the unprecedented decline in demand going coming up against a sky-high rise in production from Russia and Saudi Arabia.

While that overproduction is expected to ease somewhat when the output cut comes into play, we are staring at a huge glut, as exemplified by the shocking declines in the May contract yesterday.

US crude the target for sellers

The issue of global oversupply is not going away anytime soon, with the unprecedented decline in demand in response to the global shutdown likely to impact demand throughout 2020. Even without further major outbreaks later in the year, there is likely to be a significant decline in demand as habits are changed in response to this invisible threat. The International Energy Agency (IEA) estimates below highlight the radical three-month period ahead of us, even if we presume that there are no further lockdowns later on (questionable).

So with a huge gap between demand and supply, the question is what will happen to the crude that is being created? Brent is from the North Sea, with the availability of ship ensuring that it can be moved about relatively freely. If we see a position where ships are all taken out of the market to store product, then this could be more of an issue. However, for the now the problem is that we are seeing a huge problem with US oil, which is typically landlocked and will need to travel through a series of pielines to reach storage facilities.

Those storage facilities are expected to be full by late May, highlighting the problem that US crude literally has nowhere to go. For traders this means crude weakness is likely to be centred upon WTI over Brent. The chart below highlights the incredible widening spread between Brent and WTI crude this week. The WTI price in this chart is that given at the Cushing storage facility, which clearly had so little room for the product that it ultimately sparked a decline into -$37 for the last day of the May contract.

While this price will recover as we kick off the June contract, the story of US storage and global oversupply is unlikely to go away. After a decade on the sidelines, oil tankers are finally back in demand as traders seek to take advantage of the huge gaps between current oil and future oil.

Where now for US oil?

US President Donald Trump has already speculated that he could halt Saudi imports and fill US strategic reserves to the tune of 75 million barrels. However, with the IEA speculating that the recent drop in demand could be around 29 million bpd this month, that means it could take just three days of oversupply to fill the US reserves. With that in mind, US producers will need to cut production drastically to somehow reverse the current situation. As things stand, those producers relying on land storage will be hit first, meaning US crude will likely continue to decline over and above Brent.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

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