Oil Market Special: Little comfort in oil in uncertain times

Turn left at the end of the world, so the oil story goes

Oil prices are all about "Spot" and do not have the comfort of other assets like stocks which can look forward between 3 to 6 months or longer, given the policy backstops. With storage saturation levels rising quickly, the oil markets do not have that luxury these days.

Traders are incredibly unsure about which way the market is heading, and from my weekly roll analysis open interest has dropped notably vs. March averages along with exchange trading volumes. If my nascent cross asset price discovery plays out as I think it might, trading volumes are going to get a lot quieter over the next few weeks or possibly months – and not just oil volumes. The small basket of futures I trade and analyze is closing down May/Jun (IMM) and converging on August/ September (IMM) dates at a rapid pace, which suggests investors could be looking to avoid the front-month steamrollers at all costs.

In other words, they’re shifting hedges to the less volatile part of the curve as the bulk of the uncertainty and volatility is packed in the front end.

Oil prices found some tentative support into the weekend after a tumultuous week for the markets. Indeed, prices recovered after the gut-wrenching sell-off, but some of the recovery momenta stymied after disappointing news out of trials for anti-viral remdesivir all but ended sentiment. What was keen for oil traders, however, is the market did not overreact to the cross-asset sell-off.

Otherwise, news flow is beginning to build around producers preparing for the May 1 production cuts along with forced and compensated shut-ins. As well, traders are pivoting, which is increasingly crucial at this stage, to the demand revival as economies are beginning the process of coming out of lockdown.

Even if you’re not trading the crude oil market (which I don’t recommend to anyone but seasoned veterans) the crash provided valuable price discovery – and maybe an opportunity. Crude oil futures trading at 28.82 for December delivery is an indication of what the market – the crude oil market anyway – believes is the likely course of the Covid-19 pandemic.

It seems clear that the oil market believes that demand will revive, at least to some degree, by December. Indeed, with August trading at $24, the oil market would seem to think that we’ll be back to work pretty soon. And on Friday, with June trading over $17, the market thought we would be back to work even faster. According to all the “hot takes" on Monday and Tuesday, who would have thought that would have happened after the crude oil market crashed into reality only a few days earlier. Real oil traders did, apparently.

While the crash of the shale "revolution" will be painful for Texas and a few other states, lower oil prices are a boon for the rest of the word. I don’t even want to get into that as it’s probably a conversation for June or July. But if you think the current state of the oil markets are bad, in the famous words of a fellow Canadian Randy Bachman, " You ain't seen nothing yet."

Forget shut-ins – those are merely a consequence of the demand devastation. Given the well-publicized drop in pollution due to social distancing measures, which now impacts 90-95% of the population, the long-term effect of these shut-ins on the oil industry is still unknown. As the quantum shift in the debate around climate change will see, investors turning attention to the benefits of green energy and a preference for all this "green" could do to the oil industry what Edison's lightbulb did for the candle factory. I’m so enamored by the fall in global pollution – one of the few benefits of the virus – that this big block Hemi-loving dinosaur was kicking tires on the internet this week for a brand spanking new Tesla.

I don’t have any unique insights into the future course of the virus, and I don’t even read weekend headlines anymore. Still, my oil market timeline feels overly optimistic, and it’s probably safer to price in something that takes longer, a more drawn-out affair. Will we head back to below $10? Maybe, but as with the virus news it's best to stay on an even keel. But when it comes to oil markets, unlike the bevy of other non-commodity assets, you need to stay focused on the present instead of thinking or hoping about tomorrow.