While most of the world is still reeling from the impacts of COVID-19, ubiquitous lockdowns and economic uncertainty, the oil markets have recovered from their nadirs in March and have narrowed the deep contango.

Both WTI and Brent futures have transitioned from a deep carry, usually indicative of oversupply, to a flatter structure, which is more reminiscent of fundamental balance. While the forward curve still reflects a carry, the intermonth spreads of 1-2$ per barrel have contracted to a 10-50 cents per barrel:

This recovery in both flat price and term structure can be attributed to three factors: (1) early and wide-spread cuts in production between OPEC+ and shale producers due to COVID-19, (2) expectations of demand recovering as economies re-open and (3) OPEC+ adopting extended short-term cuts rather than long-term commitments, keeping prompt months firm.

At this point celebrations may be premature, as Bloomberg has compiled data suggesting another round of oil and gas bankruptcies may be on the horizon, due to capital destruction and negative cash flows:

Another potential risk lies with refined products, as the states that lead the jump in gasoline demand (Georgia, California, Texas, and Florida) due to re-opening are now facing further COVID related shutdowns. The current COVID situation in these states points to further lockdowns, cancellation of fall school sessions, and ultimately more demand destruction. Refinery margins remain depressed and as a result Q2 and Q3 crude unit maintenance, as seen in the figure below, remains outsized relative to past years:

Q4 crude unit operations are projected to be in-line with normal seasonality, but any weakness in gasoline demand and hence crack margins, could elicit further crude unit shut-downs, and thus more crude demand destruction.

These are serious headwinds for the oil and gas industry to grapple with, that are compounded by the problem of terminal demand, which will become increasingly important over time. The forward curve hints of this fragile balance and oversupply, but ultimately the flat price sell off seems to be in the rear-view mirror. Producers should carefully gauge their breakeven costs and economics, as term structure can provide hedging opportunities to lock in margin.

Tellus Hedge looks forward to continuing to provide our E&P clients tools to access liquidity, as hedging only becomes more important in the current environment. For those that have not done so already, please reach out to sales@tellusmarkets.com to schedule a demo of our comprehensive electronic hedging platform.

July 27, 2020