Apocalypse Oil
24 Apr, 2020
READ TIME 3 mins
Rod Skellet
Equities Investment Strategist

The most extraordinary episode in the history of traded petroleum products, occurred Monday in the US. The price of West Texas Intermediate crude oil futures, expiring on April 21st (the May contract) plunged 321% to -$40.32 a barrel, the lowest price ever recorded.

The steep fall in the price of this commodity contract is due to the unique circumstances surrounding the location of where the West Texas International price is derived. Cushing, Oklahoma, USA is a key storage hub for crude oil. It is landlocked and the oil contract itself (WTI) is deliverable rather than cash settled. The steep fall in price is because of the lack of sufficient demand for oil, remembering that with the COVID-19 lock down no one in the US is using their cars or flying, and the lack of storage given that the small production cuts have not adequately addressed the supply glut. There is just no where to put the oil.

This gave rise to the bizarre anomaly where buyers of oil were being paid to take delivery of oil. With oil storage facilities full, an economy in lockdown and demand for petroleum products cratering, will this force global producers to shut in wells? Surely those producers with debt will close first, but the key will be when will demand increase to levels greater than supply so the oil in storage can be drawn down. How long will it take for demand to recover to levels that are greater than supply? While this negative carry exists, there will be a permanent loss capital.

So, while the global oil price is going through extraordinary times, here in Australia, a country where we import the majority of our raw petroleum-based products a different dynamic exists. Do not expect to rock up to the local petrol station and expect to receive cash for filling up your tank. The WTI price has almost no relevance for our domestic prices. The key factor in determining the petrol/Diesel price here is the Singapore Mogas 95 (unleaded) and the Singapore Gasoil with 10 ppm sulphur.

As the chart below indicates, there is certainly more downside to the domestic petrol price in Australia. When the Singapore Mogas price is 30 cents per litre our pump price was circa 115 cents per litre.

Source: ACCC

That price of 115c per litre include 10% GS (11.5c per litre) and Australian Govt fuel excise which is currently set at 41.8 cents per litre. Consider the following:

From 115cpl, the governments take is 53.3 cents. From this we take away the price of the underlying commodity (Sing Mogas 95 at 30 cents per litre) leaving just 31.7 cents per litre to sustain the infrastructure for domestic refiners. Is there any wonder it is hard for domestic refiners to make money?

There are 4 refineries operating in Australia:

  • Altona in Melbourne producing 5.0 billion litres
  • Lytton in Brisbane producing 6.5 billion litres
  • Geelong in Victoria producing 7.5 billion litres
  • Kwinana in WA producing 8.6 billion litres.

These refineries are critical to keeping Australia’s economy turning, although that is a moot point right now. These refineries invest hundreds of millions of dollars each year in maintenance, to remain competitive and environmentally safe. Significant funds are also invested in ports, wharves, pipelines and terminals to provide vital links to the refineries. In addition, the industry is high tech, requiring a highly skilled workforce to ensure the industry operates safely and reliably to meet the demands of the Australian economy.

As the underlying commodity price falls (Tapas and Sing Mogas 95) the ability of the domestic refiners to stay profitable decreases. At some point, the government maybe be forced to look at the fuel excise tax, given the new norm may well be one in that petroleum prices will remain low for the foreseeable future and the refining industry like health and food chain supply operatives will be deemed critical to the Australian economy.

The views expressed in this article are the views of the stated author as at the date published and are subject to change based on markets and other conditions. Past performance is not a reliable indicator of future performance. Mason Stevens is only providing general advice in providing this information. You should consider this information, along with all your other investments and strategies when assessing the appropriateness of the information to your individual circumstances. Mason Stevens and its associates and their respective directors and other staff each declare that they may hold interests in securities and/or earn fees or other benefits from transactions arising as a result of information contained in this article.

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