Are Negative Oil Prices the New Normal?
CIBC Asset Management’s Brian See explains how oil can trade below $0, recent OPEC developments, and where oil prices may go next.
Transcript: Are Negative Oil Prices the New Normal? [Soft Music playing in background] [Title reads: Are Negative Oil Prices the New Normal?] [Onscreen Text: April 27, 2020] [Onscreen Text: Brian See, Portfolio Manager, Global Equities, CIBC Asset Management]
So when we see oil at zero or in fact negative pricing, it's really a function of too much supply in the oil market and not enough demand. And then compounded by the fact that there's really no place to store the oil. And when this happens, oil prices will effectively go no-bid, which is what we witnessed when oil prices traded at negative $37/barrel. So when the markets go through this painful price discovery, it's really a function of these futures oil contracts being unwound prior to contract expiration. And so what we mean by that is the financial holders of these contracts, they're looking to sell their positions toward the end of the month to avoid taking actual physical delivery of oil.
[Still image of an oil tanker navigating across a sea.]
And in previous cycles in the past, refiners and storage operators would be buyers of this crude. But because of their fears of crude approaching full storage capacity, they end up not purchasing it at all.
[Still image of two technicians walking through an oil refinery, followed by an aerial image of a large oil refiney.]
And then these oil contracts end up pricing to whatever is necessary in order to sell them.
[Soft Music playing in background] [Title reads: OPEC matters]
So at the latest OPEC meeting, which was an emergency meeting held between Saudi and Russia to get everyone back to the negotiating table, the OPEC plus delivered a historic deal, cutting 9.7 million barrels out of the market. Now, when we look at the numbers, the devil's in the details because the 9.7 million barrels a day cut is really only for two months, for May and June. After that, that cut actually falls to 7.7 million barrels for the balance of 2020. Starting in 2021 and all the way out to April 2022, that cut further falls to 5.8 million barrels a day. Now it's still a historic cut by any means, given the amount of production taken off the market.
[Still image of an offshore oil rig.]
And it truly helps in helping balance the overall supply markets. In addition, other oil producing nations such as the U.S., Canada and Brazil have also voluntarily cut production.
[Still image of a crew of workers at an oil derrick, followed by a still image of a single oil derrick on a snowy plain, followed by a still image of a single oil derrick on a wide, rolling green plain, followed by a still image of a long row of oil transport train cars.]
And this is really stemming from the fact that it's not only uneconomic to produce to the oil, but there's simply no place to store it.
[Soft Music playing in background] [Title reads: Impact on Canadian oil companies]
With low prices and what it means for Canadian oil companies is that solvency and liquidity are going to be the most important things in an environment of extreme price dislocation. So this means that Canadian oil companies and other global oil companies are going to have to be making sure that they can access cash, credit facilities or any debt on hand and really any other forms of cash in order to be able to ride out this volatile time. That's the most important thing. The second thing is production shut-in economics: companies are going to have to assess their assets and their various plays in order to decide which production has to be shut-in in order to preserve the balance sheet and the financial viability of the company.
[Soft Music playing in background] [Title reads: Where are oil prices headed?]
So when you look at depressed oil prices, it's really a combination of COVID and OPEC. When you're actually looking at oil, it's really facing a black swan event where you had an initial price war resulting in an oversupplied market, which was further exacerbated by the fact that the Corona virus wiped out 20 to 30 million barrels of oil demand at its peak.
[Still image of a large stack of oil barrels, followed by a still image of a man wearing a germ mask on a city street, followed by a still image of a rural gas station with a single truck at the pumps.]
When you look at that at its peak, this results in 2020 being the first year of negative oil demand since the global financial crisis.
[Still image of a set of unused gas pump nozzles, followed by a still image of a super highway being used by a single car, followed by a still image of a city highway with no cars.]
And so when you combine the OPEC cut of 9.7 million barrels a day versus the 20 to 30 million barrels a day of demand destruction, it's simply not enough to overcome weak prices in the short term. And ultimately, even with other countries moderating, the short term, prices are going to continue to be under pressure.
[Soft Music playing in background] [Title reads: Will oil demand return?]
So things will look better for oil once Canada's economy starts to pick up. But this is also dependent upon the US economy. It's important to note that Canada produces about 4 million barrels of oil and seventy five percent of this is actually exported to United States. And so the good news out of this is the US is actually demanding a lot of the heavy oil that Canada produces, and this is to replace their dwindling supplies from Mexico and Venezuela. In addition, the US has goals of oil independence and less reliance on foreign oil, such as coming from the Middle East and Africa, and this makes Canada also an attractive substitute. So in the long term, Canada's still better positioned for this. It's just going to take time for supply and demand to moderate and balance.
[Soft Music playing in background] [Title reads: Longer term oil outlook]
If we look in the long term and approximately about two to three years out per se, we're going to see this as a tremendous buying opportunity in today's markets for a couple of reasons. Number one, demand will eventually return to historical levels, post-COVID. We're already seeing early trends of less cases and fatalities, and the data seems to be trending in the positive direction. The second thing is the OPEC supply cuts and overall voluntary production curtailments are going to be effective all the way until 2022. So that's a lot of supply taken off of the market. In addition, there's also a lack of investment by the industry. And this is going to result in a supply crunch eventually down the road a few years later. Ultimately, when you combine that all together and assess our supply and demand fundamentals and marginal cost economics, we see oil prices going from effectively no-bid or very low prices today to somewhere in the realm of 40 to 50 dollars, which we view as the fair value for long term oil prices.
[Soft Music playing in background] [Disclaimer: The views expressed in this video are the personal views of Brian See and should not be taken as the views of CIBC Asset Management Inc. This video is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this video should consult with his or her advisor. All opinions and estimates expressed in this video are as of the date of publication unless otherwise indicated, and are subject to change.
®The CIBC logo is a registered trademark of CIBC, used under license. The material and/or its contents may not be reproduced without the express written consent of CIBC Asset Management Inc.
Certain information that we have provided to you may constitute “forward-looking” statements. These statements involve known and unknown risks, uncertainties and other factors that may cause the actual results or achievements to be materially different than the results, performance or achievements expressed or implied in the forward-looking statements.] |