Updated: Mar 13, 2020
Crude Oil is one of the many markets that felt a substantial shock to its price in 2020. WTI Crude prices were bullish in 2019 and only recently began their sell-off in early January 2020. This article will cover what sparked the initial sell off for crude Oil and what are the factors that led to its sharp crash in March 2020. We will also cover where we expect the oil market to go depending on the circumstance.
*Note - Its critical to remember that the majority of the volatility created in the commodities markets comes from traders having an affect on the market. These circumstances that we are about to describe are irregular and could have lasting consequences on the markets; aside from just headlines.
Crude Oil = Naturally occurring, unrefined petroleum that is pumped from the ground.
Shale Oil = A high-quality substitute for conventional Crude Oil.
OPEC = Organization of Petroleum Exporting Countries.
- 2018: U.S. had become the worlds largest producer of crude oil. This increased supply sent U.S. Oil prices into a bear market.
-2019: Crude Oil sees some bullish momentum on the back of Trade sanctions and OPEC supply cuts. Conflicts in oil producing nations such as Libya also added to the bullish momentum as demand grew higher. Production slow-downs from important oil producing nations such as Venezuela also impacted global supply, causing price to boom.
- 2020: January 2020 Crude oil price began to drop on the back of a healthy U.S. economy. Brexit resolution and China Trade conflict both seemed to end around the end of 2019, leading investors into an optimistic view of 2020. As the economy began to worsen, institutions began liquidating oil positions in order to generate cash. Institutions were likely trying to position for the market crash so that they can have liquidity to buy the dip in a lot of these undervalued markets. Corona Virus adds to the selling pressure as governments prioritize protecting their supply chains rather than holding on to reserves. Finally, OPEC's recent decision played a huge role in the crash on 03/09/2020.
Lets Talk about these events individually and how they affect the markets.
1) Traders liquidating Oil futures: This has a serious affect on markets because it can accelerate the decline of any market. Under normal market conditions it is the nature of supply/demand that dictates the price of a commodity. When you add traders/institutions to the mix then you get the cycle of human emotions (Fear and Greed). If demand for a commodity is low then it will naturally sell off since there are less buyers in the market. Traders might add short positions to the already weak market and push price further.
2) Corona Virus (Covid-19): It is almost impossible to definitively understand the extent of the impact on supply chains due to the virus. There are too many independent moving parts in the physical production and trade of oil. What we do know is that it takes people to pump the oil, store the oil, ship the oil, and sell the oil. These physical supply chains can all be affected by a sudden outbreak of Corona. What we can likely see from this is a greater sense of interdependence from high producing nations (U.S.) and an increase in imports from nations who have had to halt production due to the virus.
3) Recession Fears: Crude oil tends to get weaker amid recession fears. In the previous downturns ('08, '11, '12, '15, and 2018) crude oil has crashed as global investors dumped the commodity to get cash to cover margin calls. Some major institutions might dump certain under-performing sectors in order to have liquidity to take advantage of price breaks in other markets. In 2020 what we can see is that there has been an increase in the demand for U.S. dollars around the world (Especially Europe) so it would make sense for governments and institutions to be getting rid of this overpriced commodity to get cash before prices dropped.
4) OPEC+ Supply Cuts: This is arguably the straw that broke the camels back. OPEC +(Organization for Petroleum Exporting Countries) is an organization that exists to create a free and orderly market in the crude oil export game. OPEC moved to create supply cuts in oil production among its members, citing the Corona virus fears as a concern for oil prices. One key member that makes up the (+) in "OPEC+" is Saudi Arabia. Saudi Arabia is the largest producer in OPEC and has recently proposed supply cuts of a million barrels a day in order to combat corona virus fear. Russia, a large oil exporter and Non-OPEC nation refused to agree to the terms. Russia's unwillingness to cooperate with further rate cuts came after OPEC reached the decision without Russia's presence.
*Lets expand on this Russia / Saudi Issue:
Russia refused to cooperate with OPEC's demand for a further cut. The OPEC nations and Russia had already started supply cuts that were set to end at the beginning of this month (March 2020). Russia cited that it will resume its normal trading volume in March/April once the original round of cuts was set to expire. This did not sit well with Saudi Arabia, who, shortly after, announced that they would be doing the same. The Saudis struct back hard, letting all of their buyers know that they'll be offering a discount on their oil in April. This battle of price fixing to suffocate your competitors is dangerous for the markets and is a sure recipe for low prices. If Saudi Arabia resumes regular trading supply AND cuts their prices; then Oil could continue to fall and potentially stay around the $20-$30 until an agreement is reached.
What Comes Next?
U.S. Crude Oil (WTI) prices have broken Key levels such as the $54, $51, $44, $42, and $40. The significance of these levels being broken is to show that there was no institutional or trading volume on the Long side. Traders have accepted the supply shifts from Saudi Arabia's decision and are pricing these concerns into Oil. Long story short the prices will continue to fall into the 20's if Russia and Saudi Arabia compete over production. Since Saudi is the lowest cost producer in the world, it will win. If Russia feels the impact of the current market prices then it will eventually make a deal with the Saudis to allow an orderly market, which will stabilize Oil prices. For now lets assume prices will continue to drop heading into April unless there is news about these nations reaching an agreement.
Disclaimer: This paper is the result of the analysis carried out by analysts associated with ChartAddicts. The article does not purport to represent the views or the official policy of ChartAddicts. This is not investment advice.