By Patrick Mathabeni, 24 April 2020
Firstly, there is a difference between the West Texas Intermediate (WTI) crude oil and Brent crude oil. The differences between the two lie not only in the fact that the former (i.e. WTI) is lighter and sweeter (due to less sulphur content) than the latter (i.e. Brent), but more importantly, Brent crude is the international and widely-used benchmark for the oil price as set by the Organization of Petroleum Exporting Countries (OPEC), while the WTI crude is the benchmark used exclusively for the US oil price. It’s important to note that most oil producers in the Europe, Middle East and Africa (EMEA) region reference the Brent crude oil price, which therefore makes WTI crude less relevant for South African and emerging market investors, an exception being Nigeria, as highlighted below.
Secondly, what took place on Monday was that the oil futures for May (which were expiring on Tuesday 21 April 2020) came under enormous pressure due to the dislocation (or disequilibrium) between supply and demand. On the supply side, the price war between Saudi Arabia and Russia had exacerbated excess supply, exerting downward pressure on the oil price. On the demand side, the impact of COVID-19 has been dampening demand significantly as travelling came to a grinding halt, worldwide. In effect, storage in the US became heavily constrained as oil inventories in Cushing, Oklahoma (the main delivery hub for oil futures) rose sharply, creating huge problems for the oil futures market.
Thirdly, the way oil is traded in the futures market is that an oil futures market transaction would typically involve the long (i.e. contracted to buy) and the short (i.e. contracted to sell). At expiration of the futures contract, the short must deliver the oil to the long as contracted and then long must pay the contracted amount and take possession of the underlying commodity (in this instance oil). On Monday, however, long traders tried to get out of their positions (because of the reasons set out above and a general scarcity of appropriate storage space), by attempting to sell their contracts, however, nobody wanted it as there was no place left to store it. This temporarily pushed the futures price into negative territory. Oil prices, however, have since rebounded as the market is pricing in the reopening of economies which will bolster demand.
Finally, the price shock had very little impact on the South African stock market which is more susceptible to Brent crude than WTI crude. Brent crude was down approximately 9% on Monday and Sasol (a stock that is more responsive to the movement of the oil price) was down 3.5%, while MTN took a one-day knock of 17%. The impact on the telecoms giant was driven by its significant exposure to Nigeria whose economy solely depends on the production of oil and gas. Nigeria’s bonny light crude oil price came under pressure. What also needs to be kept in mind is that a lower oil price is positive for South Africa as importing becomes cheaper and inflation subsequently decreased, however the currency impact must be considered as well.