Within the space of a few weeks, the global market for crude oil has truly entered the realm of the surreal. Dali’s painting entitled “The Persistence of Memory” comes to mind, with its images of melting watch faces amidst a barren wasteland. After all, one has to struggle to remember that there was once concern that WTI could go to USD 200/barrel; yet, on Monday 20th April, the price for US WTI May 2020 contract fell to minus USD 40/barrel, before retracing to around USD 20/barrel in early May.
Mental “whiplash” probably cannot begin to describe the experience of long-term observers of the markets, as they try to come to terms with the seeming absurdity of recent events- a ruinous price war catalyzed by Saudi Arabia in response to supposed Russian “intransigence” over continuing a programme of relatively modest production cuts, followed by an “historic” and unprecedented agreement by the so-called OPEC+ to cut some 10 million barrels from daily supply then averaging 100 million barrels; followed by a generational collapse in the price of WTI to USD 18/barrel- and then the hitherto unthinkable and unseen negative prices within the course of a day.
And yet, as always, it pays to look beyond the headlines and ask what is the significance of what happened, given that the price of the major global crude oil benchmark, ICE Brent, while very weak, having fallen to a 2-decade low below USD 20/barrel at the same time, did not respond with as much volatility to the WTI move- opening up an absurdly wide differential of some USD 60/barrel for at least a short time – so, some 3X the price of WTI in absolute terms, and theoretically infinitely greater, as the latter was negative, which is ludicrous!
For one thing, the US WTI and ICE Brent indices, although often seen as comparable, are quite different in reach and mechanism. The former is a domestic index, for physical delivery into one geographical location, Cushing, OK; while the latter is mainly sea-borne, cash settled and global. They may seem the same, but they are not. This demonstrates the need for precise knowledge.
On the other, in the wider sense, the event is a clear signal of widespread dislocation and distress; because no such event has occurred in the recorded history of the crude oil markets dating back to Titusville, PA in 1859.
However, what no-one can yet know are the longer-term consequences of all the price volatility and precipitate fall in demand (estimated at up to one third of “normal” levels). Crude oil remains, for now at least, an essential commodity and underpins the economies of many states to a level where loss of revenues will have serious domestic and geopolitical repercussions. On the one hand, governments affected can point out that it is “not their fault”; on the other, it will reveal the fragility of their budgets and long-standing failures of policy and waste.
This situation provides yet another example of the need to look at an issue or risk holistically- both understanding its specific, idiosyncratic components and being able to set it into a wider context, and consider second and further order effects. This is an approach which is fundamental to Awbury’s risk selection and risk management. If the answer to something seems simple or “obvious”, the odds are, in our complex and inter-connected world, that one has missed a factor that could shift the risk from being sound to one where there is the danger of becoming the “dumb money”- and Awbury is not the “dumb money”!
The Awbury Team