Oil markets are facing a “a brutal few months” as prices crash to 1960s levels and available storage declines, according to Credit Suisse analyst Saul Kavonic.
Addressing a Petroleum Club of WA Virtual Event Series, Mr Kavonic said there had been an unprecedented and sudden contraction in oil demand caused by the COVID-19 crisis and a slump
in prices from the beginning of March because of a price and production war between Saudi Arabia and Russia.
“We are now looking at demand in April for oil globally that we haven’t seen since the Apollo missions to the moon in the 1960s,” Mr Kavonic said in the April event held before an OPEC meeting at which production cuts were to be discussed.
“The market simply can’t cope. We are getting to a point where global oil storage could run out in a matter of months and particular fuels, like jet fuel, could run out in a matter of weeks.
“I am still remaining wary on what oil prices are going to do. Even if we see a record cut (at the OPEC meeting) the reality is if we get a 10 million barrels a day cut or even a 15 million barrels a day cut, it’s going to be dwarfed by this demand destruction this month which could be anywhere between 20 and 30 million barrels a day.
“So, one way or another we are looking at a pretty brutal few months for oil markets. As a result, we have seen spend slashed globally. Already we have seen about a 20 per cent contraction in global oil capex.”
But Mr Kavonic said the “good side” to the story was that the contraction now was “sowing the seeds of the next oil boom”.
“We have already seen estimates that while oil prices will be quite terrible for the moment, the drop in spending that we will see in the industry now could already see a more than $10 a barrel rise in the oil price from 2022.
“But with oil prices where they are everyone is focused on the next few months; they are not worried about what might happen in two years’ time.”
On LNG, Mr Kavonic said prices were already low before the COVID-19 crisis.
“LNG prices was already very low, in the threes ($US3/MMBtu) and we have seen it drop into the twos… we actually have 15 LNG cargoes floating around as LNG storage which is a pretty unprecedented picture.
“We put this together and say for the near term we could see LNG spot prices drop below $2 and while we expect price support because US LNG is inevitably going to have to shut in here which will bring prices back up to the mid twos that could still take two or three months to realise and as a result at least for a few weeks we could see LNG spot prices drop further.”
He said the LNG sector worldwide had responded by delaying final investment decisions. In WA, that included Woodside delaying decisions on the giant Scarborough and Browse projects.
No decisions would be made until the market improves.
“Let’s say it improves and recovers again next year, it will be a very different landscape for new projects.
“In particular, we will see industry revising down their long-term oil price assumptions in order to sanction projects. Investment hurdle metrics are probably going to be tightened and I think you could see some M&A around key LNG infrastructure in WA.
“So the whole corporate dynamic which we have seen play out where we have seen Woodside try to get the NW Shelf aligned over the last two years, the dynamic around that could change next year if we see M&A, and if companies become more wary of protecting their balance sheets.”
Mr Kavonic said it was the first time in about 15 years that merger and acquisition was looking genuinely attractive versus organic growth.
“There are now distressed assets and distressed companies which you can potentially buy below the net asset backing and that’s the first time we have seen this in 15 years — or you could argue a generation.
“If you believe we are sowing the seeds of next oil boom, the next six months could present a compelling opportunity for those companies who are well placed for it, to actually acquire a big suite of tier-one assets with great growth options and then ride the oil price up over the next two years.
“But we have to get through the next few months first.
“There are only a very few players who have balance sheet strength (for mergers and acquisitions) and Woodside is one of them.”
Mr Kavonic said low oil prices could provide an indirect silver lining for activity in the Perth Basin.
“What we have seen in the decline in oil price is a decline in oil drilling onshore in the US,” he said.
“Paradoxically, normally oil and gas prices flow together. That’s now disconnected in the US where, because oil production is declining all the free associated gas with that which was flooding the market is coming off too.
“So, what you have seen is domestic gas prices in the US, the futures, have increased.
“If we are going to see long-term price support for gas in the US that improves the scope for petrochemical netbacks in WA.
“New gas discoveries in the Perth Basin, part of their market will be new petrochemical facilities. Those petrochemical facilities can afford to sign up to long-term deals at a higher price than a month ago because of this long-term structural change that has potentially happened in the US.”