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Why oil's future looks better despite storage ‘busting at the seams’

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April 23, 2020

Growing concerns about an oversupplied oil market — and the dizzying selloff in prices (CL=F) inspired by collapsing global demand — is a relatively short-term phenomenon that analysts say should be taken with the proverbial “grain of salt.”

Wall Street has been riveted by this week’s carnage in May and June contracts of West Texas Intermediate (WTI) — the latter’s price having briefly gone negative for the first time ever before rebounding in Tuesday’s session.

Crude is the latest victim of the unprecedented demand shock created by the COVID-19 crisis, which has brought travel to a screeching halt in the wake of restrictive worldwide government lockdowns. With citizens staying at home and many businesses closed, there’s currently far more available oil than places to store them.

In the immediate term, the coronavirus — combined with an internecine battle over market share between OPEC+ crude producers Saudi Arabia and Russia — is all but certain to depress oil prices and create real pain among U.S. oil companies. 

Yet at least a few market observers think that the dramatic price action is more indicative of an immediate lack of storage capacity rather than a sustainable long-term trend. 

“U.S. oil storage is busting at the seams,” said Dec Mullarkey, managing director, investment strategy at SLC Management, the $175B asset management arm of Sun Life Financial.

Although the fact that investors sent May WTI contracts reeling into negative territory is “disconcerting, the price of Brent crude and longer dated WTI futures still trade at reasonable levels,” Mullarkey added.

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In fact, contracts on the CME’s platform all show oil trading at prices well above $20 per barrel after July — something that means investors should take the current price action with “a grain of salt,” according to Jefferies macro strategist David Zervos.

Looking out at the futures curve through 2022, some contracts are forecasting a move back to the $30-40 range, he pointed out. 

“So it’s not a complete meltdown,” Zervos said, adding that this week’s action was “much more of a specific move to the very front contract and the storage problems associated with a complete collapse in short term demand.”

The second quarter is expected to be catastrophic for global growth, and most analysts expect 2020 will be a year of contraction. However, an economic rebound should help spark a fire under global demand, and boost crude prices.

“We’re in unusual times,” Rob Thummel, a portfolio Manager at Tortoise, told Yahoo Finance. 

“It’s dangerous to equate oil to the overall economy, this is specific to the storage of oil,” he said. “Eventually we’ll flip the other way from an oversupplied to an undersupplied market, and that will alleviate this storage issue that we have.”

Javier David is an editor for Yahoo Finance. Follow him on Twitter: @TeflonGeek

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