Open Lectures Week on Energy

Virtual open lectures week on energy, 26 May-2 June 2020

Within the framework of the summer “Global Energy Economy” course, Prof. Rouben Indjikian has been inviting guest speakers, and organizing annual “State and Future of Energy” events since 2017. The speakers included industry leaders and key representatives from such entities as Lundin Petroleum, IEA, Argus, Mercuria, BP, Trafigura, Gunvor as well as prominent independent consultants.

This exceptional year demanded new solutions and Prof Indjikian managed to organize within his course a week of distance lectures on closely interrelated issues of energy and mainly oil markets, which faced unprecedented shocks due to coronavirus pandemic. The lecturers and their themes included:

Neil Atkinson, Head, Oil Markets Division, International Energy Agency, Paris, “Oil markets under COVID-19 attack: current state and outlook”, 26 May, 2020

David Fyfe, Chief Economist, Argus Media, London, “What could COVID-19 mean for oil and commodity markets and the Energy Transition?”, 28 May 2020

Benoit Lioud, Senior Communications and Research Analyst, Mercuria Energy Trading SA, Geneva, “Challenges of risk management in oil markets”, 2 June 2020

All three speakers concentrated their analysis on mainly the oil market and stressed that it was the most affected market by the coronavirus pandemic, due to demand destruction as a result of massive lockdown and hence sharp decline in mobility of persons. The collapse in demand started in March, peaked in April. It started to recover slowly in May. It was preceded by the unfortunate failure of OPEC+ to achieve price stabilisation from supply side in early March. Hence the price war and increase in supply just in the beginning of demand destruction. But collapse in demand brought OPEC+ back to life in April, with even bigger cuts in oil production. However, demand shock was too big to be matched by unprecedented cuts in production by participants of OPEC+ oil supply management.

While Atkinson and Fyfe looked at supply and demand balance and prices, and their outlook, Lioud concentrated more on risk management challenges that oil transaction participants are facing and that traders try to address for themselves and other participants of international oil trade.

In his lecture Neil Atkinson, who is responsible for IEA flagship monthly Oil Market Report, reviewed the fall and stabilisation of oil futures prices, looked at world oil demand, suggesting that worst and especially falls in demand due to the severe lockdown measures like in April, might be behind us, at the same time showing different dynamics in demand of China and OECD countries. He also stressed that while gasoline demand may rebound quite quickly due to people driving their cars again, recovering demand for jet fuel will need considerably longer period due problems of air traffic after coronavirus. Meantime supply was contracted by 12mbd in May thanks to the efforts of OPEC plus Russia and other non-OPEC oil exporters as well as production cuts in the U.S.A and Canada.

However, the fall in demand was bigger and as a result OECD stocks increased to unprecedented levels of nearly 3000mb, covering 90 days of forward demand. Moreover, as the bulk of oil and oil products are shipped by sea, many tankers turned into floating storage facilities. As far as global refining industry is concerned its throughput reaching approximately 85mbd in the beginning of this year sharply declined by nearly 20mbd in May. At the same time the rebalancing of the market will bring about de-stocking and increase in refining throughput.

Oil demand was already relatively low before the outbreak of the pandemic but plummeted after. During the second part of the year, oil is expected to recover and demand to rise while oil stocks will balance out. The biggest concern is the potential for a second wave of the COVID-19 outbreak. This would clearly cause a drastic change in market expectations. However, forecasts are based on the assumption that there will be no second wave. The repercussions of a second wave are too drastic and unreliable to predict.

David Fyfe in his presentation addressed the role of Price Reporting Agencies (PRAs) and pricing benchmarks, COVID-19 and the global economy, short-term implications on oil market, and finally longer term and structural impacts for commodities and energy.

PRAs are playing the essential role of identifying and reporting fair prices including in less liquid and opaque commodity markets, by using precise and automated methodologies and networking with a wide range of market participants. Prices reported by PRAs are used as a basis for price determination in many energy commodities sales contracts. PRAs are also providing services of market intelligence and analytics to assess the state of energy and commodity markets.

Short term forecast suggests that oil demand at the end of 2022 could be lower than the demand at the end of 2019. Argus expects a drop of 7.5mb/d year-over-year. Additionally, the drop of demand for jet fuel may not recover by 2022. During the second quarter of 2020, supply loss was only half of demand loss, which among others caused high volatility in April during which the oil price of NYMEX WTI went negative on the 20th. Oil output had to be cut in order to prevent exceeding the total global storage capacity. Despite the cut, shale production is expected to recover in 2021. However, the overall pace of the U.S. oil supply will be much slower. If OPEC will follow their strategy, the market may be rebalanced by late 2020 or early 2021. Their success will depend on the answer to three questions: How will the world handle demand recovery, the economic rebound, and COVID-19 control; Will OPEC remain disciplined beyond mid-year; How will the rebound of the Shale sector unfold?

According to Fyfe, longer term issues for oil and energy include: Less than $50 oil for 2020-2022 with potential spike thereafter; Acceleration of U.S. shale consolidation with lower growth rate; Stronger competition between European and Asian refining; Pricier and lower volume long-distance tourism; Lower demand for jet fuel due less air flights and for bunker due to relocalization of manufacturing; Air and on-road transport under pressure causing delays in investment in low emission technologies and fuels; Personal vehicles gain vs. mass transit, which may boost gasoline; Tighter or deferred air quality standards; COVID-19 re-ignites food security vs. fuel debate, impacts biofuel targets; Import tariffs on solar panels as an anti-dumping measure vis a vis China price war to stimulate demand; Increased demand for food packaging versus plans to ban single-use plastics; Post-Covid financial/economic squeeze and energy transition.

Benoit Lioud in his lecture concentrated mainly on the role of traders in risk management in the oil market. One of the methods used by traders to make profit is by taking advantage of volatility and differentials in market prices, in particular, through following types of arbitrages: Geographical (differences in prices for the same commodity in different places); Quality (differences in prices for different grades, types or blends of products); Time (differences in price between immediate delivery and delivery at a certain date). Traders are also blending/transforming various sorts of oils to meet demand in certain types of qualities in dedicated markets. The pricing of multiple sorts of crude oils are defined through premiums or discounts in relation to main global benchmarks such as Brent and WTI. Those premiums and discounts reflect intrinsic physical qualities, availability, attractiveness, location etc. The lighter oils with less sulphur etc. are traded with premiums. There are two risks associated with price fluctuations: the fluctuation of benchmarks such as Brent and the fluctuation of the differentials of other crude oils priced in relation to Brent.

Traders as intermediaries are fixing prices for suppliers and buyers and manage respectively their performance and payment risks. They prefer price formulas to absolute prices because they are more flexible and resistant to risk. They can protect against uncertainty during tailor-made periods. The price formulas could be based on monthly average, a few days around the date of delivery, trigger date and can be based on either a publication of prices by PRAs or a futures price. Trading is about locking in margins while minimizing financial (price risk, credit risk, financing) and operational (quality, transport, storage, logistics, legal) risks. Being able to secure trade margins by managing floating exposures from price formulae and offloading absolute price risk is essential. Risk is a commodity traders’ “raison d’être.” A trader’s core business is to offload the risk from their counterparts and manage it, while securing the margin.

Mr. Lioud also commented on negative WTI benchmark price in April. He considered it as a result of difficulties in the futures market for a minority of participants who had to accept delivery when the future expired and were not ready to do so. In April, oil storage capacity was either used or reserved and many buyers were unable to store purchased oil due to a lack of storage capacity. This forced buyers to pay in order to store their oil as they had to figure out a new storage contract the day of delivery which was practically impossible. Participants also learned about the notion of basis risk and techniques of hedging through, futures, swaps and options.