Oil Roars Back as Demand Picks Up

Last week financial markets set up another historical precedent – the price of oil turned negative in the futures market for the first time in history. As demand collapsed due to the coronavirus pandemic, producers flooded the market, creating the biggest shock the industry has ever seen.

Those not familiar with the situation are surely surprised to hear that the WTI futures reached -$40. Yes, it meant that producers effectively paid someone to come and pick up their oil, as no storage facilities were available.

The situation created confusion on the futures exchange (CME) where WTI futures contracts trade. Due to the unusual situation, it was not clear that CME would let WTI trade negatively – as it turned out, it did, sending the price of oil in a death spiral.

Demand Starts Picking Up

The price war between Russia and Saudi Arabia did not help. Even before the coronavirus crisis reached the Western world, the price of oil fell on the announcement that the two countries did not reach an agreement regarding production cuts. With Chinese demand on the fallout, the pressure to cut production was increasingly acute, but the two disagreed on details.

As it turned out, the aim was to punish the shale oil industry in the United States. For the first time in decades, the United States became a net oil exporter in 2019, threatening the supremacy of other well-established producers. The shale oil industry revolution changed not only the way oil is extracted, but it slashed the production costs significantly.

Oil, Inflation and Economic Growth

This week spanish Repsol offered  a quick view of what to expect in terms of demand as economies begin to open up. Road fuel demand recovered to around 50% below normal levels – a good proxy for other countries in the region (e.g., France, Italy).

WTI June futures contracts picked up to well-above $20, signaling economic recovery ahead. The price of oil is responsible for much of inflation expectations. Every central bank’s research department monitors the oil market, and monetary policies easily shift on its evolution.

Thus, inflation is unlikely to be a problem anytime soon. Despite massive central banks’ stimulus programs, the increase in money supply will not return higher inflation until economic growth picks up – modestly, at first, and gradually, later.

While consumers cheer lower oil prices, a decline to unrealistic levels brings economic pain down the road. Now that we have seen negative oil prices, what else can turn negative in the commodity space?

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