As entire industrialized countries remain in lockdown amid the COVID-19 pandemic, global oil demand continues to fall at an unprecedented rate and the International Energy Agency has warned that demand for fuel could drop to lows not seen since 1995.
At the time of writing, it is suggested that demand in April will have fallen by a record 29 million barrels per day and that global oil demand could drop by up to 9 percent during 2020 as supply and demand chains continue to face increased disruption.
In fact, even if the tight restrictions on travel are lifted in the second half of the year, demand for fuel is still expected to drop by over 9 million barrels a day, wiping out nearly a decade of demand growth.
This rapid decline in demand is fast creating an oversupply issue on a global scale and, as a result, the world’s traditional oil stores are near breaking capacity. S&P Global Platts Analytics has suggested that pipelines and tanks being used to store surplus oil could be overwhelmed within the coming weeks.
With travel and economic activity across the world remaining restricted, supply is predicted to continue to outstrip demand by 19.5 million barrels per day in May. So where does the oil industry go from here?
The recent agreement by the OPEC+ cartel to cut their production output by 9.7 million barrels a day is a strong and necessary step. However, despite announcing the biggest supply cuts in history, the stock build up from the first half of the year, along with the stores of oil that will continue to enter the market until the supply cuts come into effect, still threaten to saturate storage capacity and overwhelm oil industry logistics.
The 45 million-barrel Saldanha bay oil storage terminal – the largest in the southern hemisphere – has previously been a crucial outlet for excess crude in periods of reduced demand, such as the 2008/2009 recession. However, the facility is already close to full, emphasizing how the oil industries capacity for storage is being pushed to new limits.
With many ‘on-land’ stores already at capacity, the sector is turning to tankers, either to transport or secure the commodity at sea. It is already estimated that 160 million barrels of oil are being held on oil tankers outside the world’s largest ports, with as many as 200 supertankers set to be used as floating storage for up to 12 months.
The last time tankers were used as storage vessels to this extent was back in 2009 when traders held over 100 million barrels at sea, before re-introducing stocks to the market when the economy started to recover. The hope is that a similar process will play out, however, with the extreme demand shock to energy markets escalating over just a matter of weeks, oil companies must assess all operational costs.
It is hard to gauge the world’s total oil storage capacity, but signs that the limit is being reached are increasingly obvious. Rising sea storage is one indicator alongside an increase in shipping freight rates.
Companies around the world are searching the market for places to store oil and refined fuels, including railcars in the US or in unused pipelines. Land locked producers will face a mounting issue as they find themselves far from export options with local storage full and will likely have to resort to well shut ins.
In some cases, oil producers are considering paying buyers to take the commodity off their hands. In the long run this may prove less costly than shutting down and re-booting oil extraction projects.
The reality of this situation hit ahead of the May WTI contracts closing earlier this week when the price of US crude oil turned negative for the first time in history, crashing from $18 a barrel to -$38 in just a few hours.
The outcome of the May contract exposed that the recently agreed supply cuts do little to solve the near-term oversupply problem in the global market. Free market supply/demand dynamics have been overtaken by the virus now controlling the fate of the oil industry.
As rising stockpiles threaten to overwhelm facilities, the concern now is that the emergence of negative oil prices may trigger some oil producers to temporarily shut down operations, with continuing slumps in demand expected to influence trading based on June WTI contracts.
The fact that contracts for June delivery of WTI are trading positively, albeit around $10, is encouraging. However, it cannot be taken as an assurance that the market will not experience a similar price collapse upon June’s expiry if demand hasn’t increased over the next few months.
The hope is that market recovery will start to pick up as the travel restrictions put in place to help limit the spread of COVID-19 are eased, triggering a rise in demand for fuel again. However, most market analysts are suggesting that despite a re-bound, oil prices will fail to reach the highs of almost $70 a barrel recorded at the beginning of the year.
Now storage capacity, both on land and at sea, continues to be tested like never before and as that process continues, it will keep exerting downward pressure on global oil prices.
Ultimately, it will take a recovery in demand to turn the market around and that will depend on how the current health crisis unfolds.
Whilst the current inventory overhang is already encouraging energy market participants to reflect on the challenges and associated costs of storing oil, with lockdowns still in place, it is simply too early to determine what lasting impact this unprecedented period will have on the oil industry as the direction, speed and extent of the virus impact and the counter measures fluctuate. The industry has faced severe market volatilities time and time again and bounced back. The overcapacity problem is not going to last forever however the sector’s recovery may not be as quick this time.
Boris Ivanov, Managing Director and Founder of GPB Global Resources B.V.
Recommended for you
