April 29, 2020 infosol

Undercurrent 13: “It Takes Two to Tango but not in a Contango”

19 Undercurrents with Ramifications That Go Beyond Twenty 20

  • COVID-19 and the rivalry between KSA & Russia have caused a collapse in global oil markets
  • Commodity traders’ speculations are akin to a lousy fortune teller’s prediction in an old souk
  • Many oil traders are gasping for air and “in need of ventilators” and in a state of shock
  • Negative prices for oil are the very 1st in history of mankind but not the last & maybe a recurring theme
  • The oil storage capacity around the world is bursting at the seams – onshore and offshore
  • As a result hundreds of floating oil tankers are on high seas – circling around the globe
  • Some en route to a port destination yet most just circling the shores of developing countries like ghosts
  • Consuming marine fuels with high sulphur affecting the health of citizens of coastal communities

Keep an Eye On

With millions of barrels of oil on high seas, in super tankers, there is a chance of an environmental disaster similar to Exxon Valdez, where close to 11m barrels oil were spilled into the sea.

China is the fastest growing asset management market in the world. Despite this gloomy era in the oil and energy markets many new financial products and instruments for energy markets will be devised and introduced by major US and Chinese institutions in years to come.

JP Morgan has been one of the most committed trailblazers who have secured a license to be the 1st US bank with a majority owned Chinese securities business to operate in Greater China.

Anticipate new energy derivatives and financial instruments that will be devised and developed by some of these institutions with China in mind, Many of these new financial products may introduce a “hybrid model” in which oil will be only one of the many commodities that they will take positions in and part of a broader energy basket that will include renewables as well. Commodity swap agreements are a passé and as a result we will see the emergence of new models in energy markets.

Despite the slowdown in the global economic activity, if prices continue to remain at such low levels one could anticipate a potential upsurge in the China’s SPR (Strategic Petroleum Reserves). If China decides to go about increasing its SPR it can deploy major capital to establish a rapid-tank farm development program close to its refineries. While building a massive oil depot is much more complex than building a hospital (Huoshenshan in Wuhan which was built in 10 days) China is determined to mobilize and to create new employment and economic activity in regaining part of the lost growth rates.

Meanwhile China will continue to undertake some discount shopping on international energy markets for future contracts, capitalizing on a historical Contango (Contango is when spot prices trade below the prices of future delivery contracts – don’t forget the future is uncertain).

In between many mid-size energy trading and shipping firms like Hin Leong in Singapore will go under. This can turn the dial in favour of China, some of the SWFs from the Middle East and Singapore and Asian IOCs such as Sinopec who may take a position to develop an end-to-end value chain.

These days the topic of bringing back manufacturing from China and on shoring to shorten the supply chains and minimizing the risks of future dependence on China is a recurring topic in EU, Japan and US. Such decisions take many years to fully manifest and as a result of dwindling energy prices we may see a set of new low manufacturing costs in Asia and China in particular, which could delay and affect such decisions if we face a global recession.

At the moment the music of global trade is on pause, once the music starts again we may all realise that this time around it takes more than two to tango!

Ali Borhani is the Managing Director of 3Sixty Strategic Advisors Ltd. It is the readers’ responsibility to verify their own
facts. The views and opinions expressed in this article/commentary are those of the author’s and do not necessarily reflect the official policy or position of any other individual, agency, organization, employer or company.