Bank of America Global Research | Oil futures have collapsed by more than 60% since the start of the year, with the WTI front month contract testing $20/bbl several times in recent weeks. The dramatic decline in prices is attributable in part to the oil price war, but the primary driver has been demand. As coronavirus fears forced governments around the world to shut down their economies, demand for refined products has been hit particularly hard. This year, we expect demand to trough in April, falling 23mn b/d below year ago levels, before recovering into the end of the year. Demand should contract this year by an average of 9.2mn b/d .
An unprecedented demand shock is rippling through every corner of the oil market, resulting in exceptionally volatile price swings. While OPEC+’s historic 9.7mn b/d production cut has lent support to the global Brent market, it has done little to liſt benchmark crude oil prices or ease North American crude oil differentials. An overnight shiſt in refinery demand leſt crude oil stranded across the country. The market is using two key levers to help move towards some semblance of balance. First, WTI futures flipped from backwardation to steep contango to encourage storage on a large scale. Second, North American crude differentials have blown out, depressing in-basin prices to choke off some production.
...doing the market’s dirty work, pushing oil into storage…
As soon as US refiners cut runs, WTI timespreads began to weaken, with WTI 1-3 spreads collapsing to -$12/bbl this week. This level was last seen in 2008 before shale reshaped Cushing’s role in the oil market. With exceptional storage economics, it is not surprising that Cushing crude inventories built at a record pace of 15mn bbl. Now, Cushing storage utilization sits at roughly 70%, and WTI 1-3 spreads suggest the hub could reach its operational limit within weeks. Meanwhile, the remainder of the curve is much flatter, with the WTI 3-5 spread (July-Sep) trading at just -$2.40/bbl. In our view, this spread could weaken if the surplus persists into 3Q20. But as producers respond to low oil prices with historic production cuts, the pace of builds at Cushing and across the US should slow.
…and forcing NAM E&Ps to shut-in and take ‘frac holidays’
WTI has traded at a premium to nearly every North American crude grade recently, even USGC barrels at times. A return to normal price relationships will depend on supply losses, storage constraints, and the recovery in refinery demand. As Cushing fills, we expect USGC grades to return to a premium over WTI. We see upside risk to the Mid-Cush forward curve as Cushing fills, Permian output collapses, and refining demand eventually rebounds. Pressured by the OPEC+ cuts, US storage should rise relatively faster than other regions. Unless US production cuts are larger than anticipated, WTI-Brent spreads should widen as more North American barrels compete to get onto the water. Then, if the US overflows, Brent timespreads may need to widen to facilitate floating storage, especially if global demand remains depressed.
