The crisis in the US oil market following the historic collapse of WTI May contract price into negative territory (minus $36 a barrel) at the threshold of contract expiry is something that was waiting to happen, given the market fundamentals.

The US continues to pump out humongous quantities of oil (12.3 million barrels a day) even as storage installations are overflowing and demand growth is non-existent. Although the US President played a catalytic role in bringing Saudi Arabia and Russia together for cutting output, the US itself has not participated in the OPEC+ decision to cut output.

Demand destruction

The market is clearly oversupplied at the moment. While global output is around 100 mbd, the estimated volume of global oil demand is only 70-75 mbd. In other words, we see demand destruction to the extent of 25-30 mbd.

This follows the rapid spread of Covid-19 pandemic across the world. Lockdown of many countries has adversely affected a wide range of energy-consuming economic activities. The 9.7 mbd output cut recently agreed to by OPEC+ obviously falls far short.

With the bleak prospect of crude oil prices recovering sharply any time soon, a violent shakeout in the energy market appears imminent. The oil rig count in the US has already dropped sharply to 468 as of April 18, down 66 rigs in a week’s time. Job losses have mounted to well over 50,000.

Although the US govt is not keen on regulating or curtailing its own oil production, there is likely to be a bailout package soon for the shale drillers who may be paid not to produce. The process of falling rig count is expected to continue as there will be gradual exit of less cost-efficient units. Players with adequate staying power are too few.

No storage room

On their part, investors and financial stakeholders are discovering how ruthless and unforgiving this market can be.

The market fundamentals for WTI, a US-centric commodity, are unlikely to change any time soon. With storage tanks filled to the brim, there is no room to store output. This means production will have to fall. This could lead to a violent shakeout in the oil industry, notwithstanding the financial package promised by the US President.

The mayhem in WTI trade can potentially play out once again by the end of May (when June contract comes up for expiry) if the market fundamentals were to worsen.

Following WTI, the global benchmark Brent too has come under pressure, falling to around $16 a barrel. Obviously, there is panic in the market as too much production is chasing limited demand, and storage installations on land as well as supertankers on water, are bursting at the seams.

How OPEC+ will respond to the latest situation is unclear. But it is clear the oil market will witness extraordinary volatility in the weeks ahead. Rebalancing of the oil market will be far from smooth and will take considerable time.

(The writer is a policy commentator and global commodities specialist. Views are personal)

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