European markets trade lower – Oil: How high can It go?

European markets are trading lower as investors are concerned about the overall 1 million-plus virus infection number. No doubt that the world is going to look different because this lethal virus has taken over 53,000 lives in only four months. The global economy is likely to shrink more than 2% during the first half of 2020 due to the public health crisis. The US, the biggest economy in the world, has the most cases, more than 245K people are infected according to John Hopkins University. The weekly jobless number printed a number which was higher than 6 million yesterday, and it is likely that the jobless rate could reach more than 31% in the coming months.

One market which has experienced wild swings yesterday, and it is likely to be the case in the coming week as well, is the oil market. Donald Trump jolted the market in the late afternoon (European trading session) when he ramped up the expectations about the oil supply cut. With just one tweet, he pushed the oil prices up as much as 21%. He conjured up the chances of a global alliance to rescue the oil industry that has been hit hard.

 

Death Angles

WTI crude at $20 was certainly sending death angles for the US shale industry as the market price was much below their breakeven point. Very few, if any, US shale oil producers can survive and remain healthy if the price of WTI is even at $30. During recent weeks, we have seen a number of companies applying for bankruptcies because it was simply impossible for them to survive.

If the default rate starts to pick up serious momentum, a highly likely scenario, then the recovery from this disaster becomes chief damage. This kind of injury cannot be repaired overnight. This is because it becomes more of a structural issue, and the jobs that are lost under those circumstances take a lot more time to come back.

 

Positive Sign

It is certainly a positive sign that Donald Trump has stepped into space. Without his intervention, the industry would have suffered more because what we need right now is higher oil prices for the US shale oil industry to survive.

 

Coalition- A Powerful Idea

The idea that has emerged with Trump's intervention in curtailing oil supply oil is a global coalition—meaning all oil producers coming together and taking collective action to reduce the oil supply. This means OPEC, Russia and the US deciding together on the oil production—the supply.

On one hand, this is certainly what the industry needs because the US has been ramping up production in the past years at the expense of others. The previous oil supply cut by the OPEC+ has benefited the US shale oil industry, and it has produced less dividend or the desired results for the overall oil industry. On the other hand, getting all parties to agree on something isn't that easy.

If Trump can bring all the partners under one roof and get them to agree on the supply cut, that would be a big thing. Remember, Saudi Arabia remains in the driving seat still because of its ability to pump more oil because their breakeven is much lower, but all major oil producers deciding collectively about the price is certainly a positive sign.

 

Is It A Supply Issue?

There is always a question if the current stampede in the oil prices is because of the supply or if it is something else such as demand not being sufficient?

The whole world is in a lockdown, economic activities are not even close to their normal levels and this clearly explains that the issue is mainly with the demand.

It is the demand that has been hit hard and until and unless we do not see the economic activity returning to its normal level and global growth back in the expansion territory—as we are about to see a major recession—it is arduous to knit a scenario under which oil prices can jump back above the $40 mark.

 

Expectations

As per Trump's tweet, the expectations have been set for 10 million barrels or more per day, and this means pretty much whole of the US production or reducing the Saudi oil production by 10 million and leaving the remaining 2 million. Of course, under a coalition, it is not one country that takes the hit, the burden is shared by everyone, but I think it is difficult for the OPEC plus to agree on this number. The number which was tweeted by Donald Trump is good enough to drive the algorithms crazy but if it can become a reality, that is a different question.

 

How High The Oil Price?

The question is if we do get this 10 million barrel per day production cut, how much can the oil price rise? In my opinion, it is difficult for the WTI crude price to top the $35 mark even if we get the desired production cut. The likely jump in the WTI crude oil will be between $30 to $35. The major issue is with demand here, and reducing supply will certainly help, but it will not be enough to push the price back above the $40.