WTI Crude Oil Prices Reverse After Coronavirus Outbreak
Midway through February 2020, oil prices are down. The price of WTI crude oil, listed on the Nymex, is approximately $50.65 per barrel, while the price of Brent crude oil, listed on the ICE, is approximately $54.80 per barrel. Futures contracts on crude oil, for delivery in March and April 2020 are slightly down, in tandem with current expectations in the oil market. The volatility of black gold is well known to traders and investors; it is both revered and reviled owing to the impact of wild price swings on profitability. Just recently, it was reported that British Petroleum (BP) profits plunged after weak gas prices and oil prices were reported. Yet, this didn’t stop the retiring chief executive officer of British Petroleum, Mr. Bob Dudley from increasing dividends to shareholders as a parting gift.
Driving negative sentiment in the oil markets is the global health crisis – the coronavirus outbreak. There is a growing sense of concern that this virus could become a pandemic if it is not contained quickly. Already, experts are talking about a reduction in oil demand by approximately 500,000 BPD. This is precisely the type of information that traders want to know. Plus500 offers oil trading to its clients and it reported a spike in put options on crude oil, given the hullaballoo taking place in markets of late. Speculators have pounced on the flu outbreak with short options on crude.
Macroeconomic Variables Weighing Heavily on the Price of Crude Oil
The impact of reduced oil demand is felt immediately in the price of crude oil. Given that the demand curve is a downward sloping curve from left to right, the lower the demand, the lower the price. By the same token, suppliers are forced into a situation where their production is not being used up by the market and results in increased inventory levels. This will invariably increase stockpiles of crude oil well into the foreseeable future, cutting production and profitability in the process.
BP has suffered greatly as global oil markets recoil with the current outbreak. Profits for the year ending in 2019 plunged by 21%, to just £7.7 billion. The fear, as driven by speculative sentiment, is that China’s once voracious appetite for energy commodities like crude oil and natural gas is waning. If this is true, it is a negative omen for the industry. OPEC is not taking this lightly either. They have called for emergency meetings to be convened to discuss the current downturn in oil demand, owing to reduced productivity and speculative fears.
At the end of January, Royal Dutch Shell (NYSE: RDS) reported its quarterly earnings and full-year results for 2019. As expected, profitability was down by 48%, despite warnings issued ahead of time. The actual results were far short of expectations, leading to a rout of the RDS stock price on the markets. Year on year (Q4 2019 versus Q4 2018) Shell earnings dropped from $4.767 billion to $2.9 billion.
These reduced profits were the direct result of lower prices for liquefied natural gas, realized oil, and standard gas. For the full year, Royal Dutch Shell reported an earnings slip of 23%, at just $16.462 billion, reducing cash flow for the full year and the final quarter of 2019. Yet, for Shell the reasons cited for reduced earnings were lower natural gas and oil prices, and macroeconomic variables for chemicals and refining. The company will continue its $25 billion share buyback program, although at a slower clip.
How Are Traders Approaching the Oil Markets?
The volatility of crude oil markets has not dampened sentiment with traders. This is particularly true of oil futures contracts which are highly active. Since oil is sensitive to macroeconomic variables such as geopolitical shocks, the recent coronavirus outbreak, global tensions, speculative sentiment and others, it is a prized commodity for day traders and swing traders. This volatility comes with a caveat: oil price movements can generate substantial losses for traders. Many peripheral markets are dependent on the price of crude oil, notably natural gas and petroleum. Beyond energy commodities, crude oil pricing also impacts energy-based stocks.
There is a clear correlation between oil prices and economic performance, given that the global economy relies heavily on energy to fuel growth. While alternative technologies are being touted as potentially viable means of supplanting the oil industry, this has not happened and likely will not happen at scale for decades. Crude oil contracts are traded on the Nymex under the ticker CL. The contract size is a minimum of 1000 US barrels, and contracts are valid for each of the12 months, January through December. Prices are quoted per barrel and the tick size is $0.01 PB. Oil futures trading is best left to the experts, and not advised for novice traders.
Traders typically rely on a handful of economic data releases to make important trading decisions vis-à-vis crude oil. These include the Weekly Energy Stocks Report released by the US Energy Information Administration. This report is released on Wednesdays 13h:00 (Eastern Standard Time). Seasonal fluctuations in demand have an outsized impact on the prices of crude oil, with high demand in winter when it is cold and generators need to be used for heating, and in summer when people are traveling more.
Producers Willing to Step in and Bring Equilibrium to Markets
Since OPEC is the leading body for Brent crude oil, any announcements to cut production are geared towards clearing inventory from the markets and reestablishing equilibrium between demand and supply. Increases in supply typically reduce prices. At this time, China purchases 200,000 BPD from the US. That’s a small fraction of the 8.5 million BPD that the US currently exports. When WTI crude oil falls below the critical $50 per barrel support level, this hurts US manufacturers and leads to the shuttering of operations.
Adding fuel to the fire is the tightening in credit markets. With lenders less inclined to advance lines of credits to buyers, oil exporters are suffering. When WTI crude oil drops below $50 per barrel, oil companies adopt belt-tightening measures. These include layoffs, and sometimes even shuttering of operations entirely. The EIA reported on December 20, 2019 that US oil production reached 12.04 million barrels per day in December 2018, while natural gas withdrawals reached 108.56 Bcf/d at the same time.
The total US oil rig count for the week of January 31, 2020 is 675,000, down from 862,000 a year ago. All of this points in the same direction: oil production is lower year on year, and there are many macroeconomic factors contributing to this. A speedy resolution to the coronavirus will serve the needs of the oil industry well and allow prices to rise. Speculative sentiment will turn bullish and this will pave the way for additional productive capacity.
