When Will U.S. Oil Storage Reach Its Limit?

1. EM currencies hold up against oil

- Sixteen of 25 emerging market currencies analyzed by Bloomberg are trading near their highest levels in 15 years against Brent crude.
- Typically, oil market downturns drag down a list of oil-producing countries, and the impact bleeds over into broader emerging market assets.
- The data suggests that EM assets are right now tracking economic performances, with an obvious eye on the pandemic. But notably, oil is doing very little to their currencies.
- “If the virus is contained in the next few months and we get a strong economic recovery, I would expect EMFX to outperform oil prices,” Brendan McKenna, a currency strategist at Wells Fargo Securities in New York, told Bloomberg.

2. Rig count nears all-time low

- The U.S. rig count has utterly collapsed, falling to 465 on April 24, down 45 percent in just five weeks.
- The rig count is now closing in on the all-time low of 404 (reached in 2016), dating back 70 years. The low point before that was 488 in 1999.
- “Permian activity is now less than half that needed to offset declines; we estimate Permian oil liquids output will fall 1.08mb/d (23%) by year-end at current activity levels,” Standard Chartered said in a note.
- The bank estimates that output in the Bakken will fall from 1.39 mb/d in April to 1.03 mb/d in December, and output in the Eagle Ford to fall from 1.34 mb/d to 0.87 mb/d over the same time frame.
- In total, production in the Permian, Eagle Ford and Bakken will decline by 1.9 mb/d.

3. Oil credit quality increasingly junk

- The U.S. oil and gas sector holds $744 billion in outstanding debt, out of $7.9 trillion in total corporate debt.
- Roughly 52 percent of all oil and gas debt was either below investment grade or very close to it, according to IEEFA.
- “Most of the exploration and production sector is overleveraged and facing a spate of bankruptcies,” IEEFA said in a report. “Upcoming debt maturities are an ever-present reminder of this unsustainable business model.”
- Today, the energy sector only accounts for 2.6 percent of the S&P Index, compared to 28 percent in the 1980s.

4. China’s industry rebounds, but other sectors lagging

- The shutdown of parts of China’s economy and widespread travel restrictions led to a sharp drop in industrial activity, and with it, a collapse of copper demand.
- However, recent data shows a swift rebound in copper demand. “Big infrastructure plans and virus-related supply disruptions could support metals prices here,” Bank of America Merrill Lynch wrote in a note.
- But the rebound is mixed and depends on the sector. Hotel rates are low. Road traffic is rebounding but air travel is a fraction of its former self.
- Bank of America sees China’s GDP rising by 1.2 percent in 2020.
- The investment bank warned that there could be a “structural drop in travel,” which is the bank’s baseline assumption for oil demand in 2021. Behavioral shifts could be semi-permanent.

5. U.S. oil storage reaching record levels

- Between March 13 and April 24, U.S oil inventories jumped by 74 million barrels. Storage now sits 8 million barrels below the record high reached in March 2017.
- Half of the country’s refining capacity is located on the Gulf Coast, and it also hosts the most storage capacity. Gulf Coast inventories rose by 36.4 million barrels between March 13 and April 24, a 20 percent increase.
- Cushing is approaching capacity, a crucial location because of the physical settlement of the WTI contract.
- “[W]ith the worst of the logistical friction caused by high inventories still to happen during May, we think the grounds for a sustainable rally in front-month Brent beyond USD 25/bbl are currently limited,” Standard Chartered wrote in a note. “Our Q2 average Brent price forecast is unchanged at USD 23/bbl; we do not expect the quarterly average to move above USD 30/bbl until Q4.”

6. Oil majors take on debt

- Royal Dutch Shell (NYSE: RDS.A) made big headlines on Thursday when it announced that it would cut its dividend for the first time since World War II. The move puts pressure on others to do the same.
- The majors have stubbornly increased dividends with each passing year, a payout they have refused to touch in even downturns.
- ExxonMobil (NYSE: XOM) has added about $53 billion in net debt over the past decade. Chevron (NYSE: CVX) has added $29 billion in debt.
- Goldman Sachs recommends the majors follow the example of major mining companies BHP (NYSE: BBL) and Rio Tinto (ASX: RIO) who switched from a progressive dividend policy to a variable payout, which results in rising payouts when cash flow is at a high and vice versa.
- For now, ExxonMobil especially seems intent on maintaining its dividend, which will require piling on more debt.

7. Renewables to fare better than fossil fuels

- The IEA said that renewables may be the only winner among energy sources this year. Global coal demand fell by 8 percent in the first quarter, year-on-year. Oil demand was down 5 percent and gas consumption was off by 2 percent.
- For all of 2020, the IEA sees total energy demand down by 6 percent, the largest decline in 70 years. COVID-19 will hit energy demand by seven times more than the global financial crisis in 2008.
- Renewables will fare much better, largely because when electricity demand drops, renewables are dispatched first because of low (i.e., zero) fuel cost.
- Total renewables generation could rise by 1 percent this year. Meanwhile, oil demand is expected to contract by 9 percent; coal by 8 percent; gas by 5 percent.