This updated article was originally published on April 23.
There’s no easy way out of the global oil glut that’s caused a historic, and occasionally bizarre, collapse in crude oil prices this spring, according to a long-time commodity-focused hedge-fund manager who has scored big gains during the market’s slide.
The next four to six weeks are all but certain to see continued increases in crude oil inventories as a result of the demand destruction wrought by the COVID-19 pandemic and a reluctance until recently by major producers to curb output, said Doug King, co-founder and chief investment officer of the London-based Merchant Commodity Fund, in a Wednesday interview. That could translate into ”extreme weakness” over that stretch, he said.
The fund, which has benefited in part from short bets on gasoline, crude and other commodities, is up 34% year-to-date, King said.
“The industry seems to be a little bit reluctant to take the medicine that everyone else is taking — shuttering, furloughing, trying to balance supply and demand,” King said. “Obviously it’s a huge part of the wealth of many, many countries and so I understand it’s extremely painful, but it is no different to what is happening around the world with every other sort of resource or company who’s been told to produce 20% less than they were or 30% less than they were.”
Instead, the world was flooded with additional crude as Saudi Arabia and Russia engaged in a price war that began in early March and that was ended just last week with an agreement by major producers to curb output.
When the lockdowns end, much will depend on how quickly economies can revive and how producers, including those in the U.S. shale patch, continue to respond, King said. That would allow inventories to stop rising and begin to plateau, though if the lockdowns extend into June or beyond, things will get only more difficult.
As economies come back to life, oil refineries won’t be roaring immediately back toward full capacity. But a pickup in gasoline demand, which has been destroyed as motorists stay home and airlines are all but grounded, could finally put a lid on rising crude supplies. Capacity utilization at U.S. refineries was at a 12-year low of 67.6% last week, according to Energy Information Administration figures.
Refiners are running at low capacity because gasoline demand has fallen as much as 50%, and storing gasoline is more onerous than storing crude or distillates, King said. The Oil Price Information Service estimated that March gasoline demand fell 19.1% versus the same month last year, while demand in the first half of April was down 48.8% versus the same time frame in 2019.
Indeed, gasoline was a big part of King’s strategy this spring. Short bets on gasoline futures US:RB00 paid off in a big way in March. King, a veteran commodity trader, said experience trading in the physical energy markets gives the fund an edge.
“You need to understand impact of what demand destruction can do, and what is available storage, and what people will do refining-wise to solve the problems,” he said.
Front-month Nymex gasoline futures US:RB plunged 76.5% from a Jan. 6 close of $1.7544 a gallon to 41.18 cents on March 23. Gasoline futures have retraced some of that decline, but fell 7% last week to end Friday at 66.12 cents.
Front-month Nymex WTI futures US:CL, the new front-month, fell 32.3% last week, the largest percentage decline on record, according to Dow Jones Market Data, to end Friday at $16.94 a barrel and is down 73% so far this year. Brent crude UK:BRN, the global benchmark, fell 23.7% last week to end Friday at $21.44 and is down 67.5% year-to-date.
The latest round of turmoil in the oil market has been blamed for renewed volatility in the stock market, with the Dow Jones Industrial Average US:DJIA and S&P 500 US:SPX falling earlier last week as oil prices collapsed and bounced Wednesday as crude prices stabilized.
King and others at the fund have experience trading in the physical energy market, which he said allows them to “understand what’s happening in the in the oil market at the real guts of it rather than just a number moving up and down on a on a screen.”
Without that experience it’s easy for traders to get wrong-footed by headline numbers, including large production cuts that are less impressive than they initially sound once existing levels of output are taken into account, he said.
And then there’s the bizarre. On Monday the now-expired NYMEX May West Texas Intermediate crude contract made history by sliding into and settling in negative territory. The May contract traded as low as minus $40 a barrel as traders, unable to find a place to store crude if they were to take physical delivery, paid others to take if off their hands. There was no corresponding move in the underlying physical market, King said, which indicated that there was a “breakdown” in the expiration process.
King said trading the slide has been stressful at times but that the fund has “navigated a few things well.
“Have I been super bearish all the way? No, not really, but there’s been a lot of opportunities that we managed to capture,” he said.