• Despite the cut in production by OPEC+, oil prices have now fallen to $18 per barrel which is the lowest in 20 years. They are now down 20% within the last week. The issue no longer about demand. It is about lack of storage capacity. Oil prices in some regions have even fallen to negative due to the cost of storage. The US government has offered its emergency storage capacity as well as pay drillers to keep the oil in the ground. Since oil is priced at the marginal level, there could be a sharp jump once the storage situation is resolved. However, structurally oil prices will remain under pressure. We expect a recovery in prices in 2HCY20 when demand starts to pick up.
  • However, till then prices are expected to remain under pressure as storages are piling up and holding costs increase; we opine an average rate of USD 25/BBL for the Jun’20 quarter.

Unfolding supply-side dynamics; not enough to strengthen short-term market outlook:

  • The weakness was despite the coordinated production cut agreed upon by OPEC and non-OPEC countries, to the tune of 9.7 MN BPD, or ~10% of total global production (Annexure A: Crude oil production cut by country).
  • Furthermore, operational rig count in the US has fallen from 793 on March 6, 2020 to 529 on April 17, 2020 (Annexure B: North America Rig Count). US crude oil production has fallen from 13m BPD during the first week of March to 12.3m BPD during the week ended April 10.
  • Additionally, an estimated 5m BPD is expected to be reduced from the supply from non-OPEC+ countries, as financial viability is hampered due to low prices.

Global crude oil demand forecast continues to look bleak:

  • According to the International Energy Agency’s April oil market report, demand during 2020 is expected to be lower by 9.3m BPD Y/Y. However, the situation is expected to remain dire for the remainder of 1HCY20, with demand during Apr’20/2QCY20 projected to be lower by 29/23.1m BPD Y/Y, respectively.
  • OPEC’s recent Monthly Oil Market Report (MOMR) on the other hand paints a relatively more positive picture, with the total demand during 2020 projected lower by 6.85m BPD (Annexure C: Quarterly OPEC projections). The demand is expected to fall by 11.86m BPD Y/Y during the Jun’20 quarter.
  • This paints a bleak picture for crude oil prices up till Jun’20, when the cut from OPEC and non-OPEC countries, and the ~5 MN BPD reduction in other countries’ output, would be enough to narrow the gap between demand and supply in the global arena.

Storages filling up around the world:

  • Another facet that is taking its toll on crude oil prices is storages. According to Bloomberg data, 122m BBLs of crude oil was stored in global floating storage as of April 17, 2020, higher by 37.5% W/W (Annexure D: Global Floating Storage vs. Crude oil prices). EIA data pointed towards tank and refinery storages in the US being 57% filled as of April 10, 2020, compared to 47% at the beginning of the calendar year (Annexure E: US Inventory vs. Storage).
  • Furthermore, as a result of the heightened demand for storage, freighter rates have also seen an increase, with prices mimicking those seen during the 2008-09 financial crisis (Annexure F: Charter Rates for VLCC).

Negative prices experienced in some parts of the globe:

  • According to recent news reports, due to the shortage of storage capacity, certain crude oil grades have seen prices drop more sharply than the benchmark of the region, with certain grades even fetching negative bids (Annexure G: US Crude Grades vs. Benchmark).
  • To illustrate, physical spot prices for WTI Midland traded at a premium to the benchmark WTI front-month future at the beginning of the year (Jan’20 avg. spread from WTI (CL1): USD 0.76/BBL), however due to a shortage of available storage capacity, the spread averaged negative USD 2.24/BBL during Mar’20.
  • Paving grade crude oil, Wyoming Asphalt Sour, traded in the red during Mid-March this year, due to the low demand and the high storage costs. Last month, the spot prices of the grade went down to as low as -19 cents/bbl.

Crude oil outlook:

  • Short-to-Medium term outlook:  We continue to believe that the demand through 2QCY20 would remain lackluster and the production cuts will not be able to sustain the prices, hence we foresee an average rate of USD25/BBL for Arab Light during the three-month period. However, following Jun’20, we believe economic activity will start picking up pace, albeit slow at first, where we see prices rebounding to mid-USD 30/BBL levels.
  • Long-term outlook: For our long-term outlook, we believe crude oil demand would pick globally, leading to prices trading back up to the USD 40-45/BBL price levels.

Outlook for E&Ps

  • Due to the outlook for crude oil prices, we incorporate USD 25/BBL for 4QFY20. Furthermore, we incorporate USD 30/BBL for 1HFY21, following which USD 50/BBL is incorporated for our long-term assumption. Following the incorporation of the new crude oil assumptions, our target prices have been revised downwards. We continue to rate the sector Outperform, with OGDC (TP:  PKR 178/sh; Upside: 85%) and PPL (TP: PKR 163/sh; Upside 88%) our top picks.
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Crude Oil Outlook: Oil falls to 18 years low

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