Mercuria’s Marco Dunand talked to S&P Global Platts about the challenges, implications, and opportunities that the coronavirus pandemic presents across all the key commodity classes in a time of unprecedented volatility in the global markets.
Founded in 2004, Mercuria Energy Trading is one of the world’s biggest independent energy traders with a turnover of $116 billion last year. Operating in more than 50 countries, Mercuria trades oil, petrochemicals, biofuels, natural gas and LNG, power, coal, iron ore, base metals and a range of other dry bulk commodities.
Marco discusses WTI’s unprecedented plunge in price in April, gives his outlook and price predictions for the oil market in the near-term, and also touches on the global LNG glut and opportunities and challenges of trading in a renewable energy age. Marco was speaking to EMEA oil senior editor Robert Perkins on June 2.
In April ’20, we had some WTI benchmark prices dip into negative territory, and traders struggling to find storage space. Looking at the oil trade and storage arbitrage, how did Mercuria cope at that time?
First of all, obviously, a company like ours is built for uncertainty. Our job is to try to balance the market. The surpluses and deficit, whether they’re on the financial side of commodity or whether in physical segment. So when we see discrepancies, obviously, we try to arbitrage, we try to provide liquidity on both sides.
From my experience, we’ve never been at tank top. We never were close to tank top. It was some of the reason given by people for the market going negative. We see the reason, we’re different – you cannot be a tanked up on a Thursday night and not a tacked up on the Friday morning. Therefore, the tank up situation was a fear was not a reality.
I think the reason why the market did what it did is because there were large positions, which will enhance the retail investors who wanted to stay in till the day before the expiry day, with some long position, but with no ability to take delivery of physical law and therefore had to sort of roll the position into the next month to liquidate them.
I think it’s more to do with the instrument created for this retail investor than to do with the tank top or physical reality of the markets.
To what extent has that trade now played out, where that retail money has washed itself out of the market? What would you say is the next staging point that the market has to look at as a cue for prices?
What you have to understand is that up to 50% of your open interest was held by retail investors. So that’s going to – you’re talking about hundreds of millions of barrels, which are held in different vehicle created for them. Some of those vehicles have been created in the US, some of them in Asia, you have China, you have Korea. Each of them have different rules.
Some of them kind of have the rule that the fund has to roll 1 month before expiry. Some of them has another rules. So since that experience, the rules have changed for everyone, the biggest US funds have moved their position and spread them over several months. Therefore, we should not see a repeat of what we’ve seen.
What is your outlook for oil prices and market balance?
We see a consensus between the Saudi, the US and the non-OPEC members, to get the market to $40. We – I think a sub-$40 market creates a lot of pain for all those countries. And I think there is a certain consensus to get it there. The question is, is there a consensus to get the market to $50? Is there a consensus to get it higher?
To really see the US industry, shale industry, starting again with the amount of losses taken, you probably need a market closer to $45, $50. Is there a consensus among OPEC, non OPEC, US, to get the market towards $45 and $50, I don’t really have the answer to that question. So I would almost say that easiest part has been done because we’re getting closer to $40 now.
It may well be that [OPEC] decides to meet on a more frequent basis because when you have swings of demand of several million barrels a day is difficult to predict the future. The question is, if we reduce the overhang, if we get closer to pre-coronavirus sort of storage [levels], logically, the market should go higher.
Right now, you have a situation where OPEC/non-OPEC, I think, is going to almost micro-manage the markets, and I don’t know that they all have a similar objective in terms of prices. So my guess is that we’re going to hover above $40, but we need to see the overhang of inventory coming down because when you have close to 1 billion barrels of extra inventory, it’s very difficult for OPEC/non-OPEC to monitor the market and somehow to control its pricing action.
So we would expect a time spread to come in to kind of incentivize people to sell their oil from inventory. And I think that only in a couple of months’ time, or maybe 3 months’ time, we’ll have a better idea about the longer-term prices. My guess would be that $50 would be a realistic target.
In this period of unprecedented LNG oversupply, when does Mercuria expect the global LNG market to rebalance?
That’s going to take some time. We expect US gas to start performing better next year because you had a lot of shut-ins. You had the arbitrage closed for LNG export, cancellation of exports, we’ve seen that actually even in the last few weeks, where essentially, the US price itself, almost at the level to imports, LNG from other regions. There were 2 cargoes, I think, one for Nigeria and one I can’t remember from where we’re going towards the US. So the market is still trying to find it’s floor.
It still needs Asian demand to come back. It still needs India to be back in full swing. And I think then fundamentals will definitely improve as of next year. It’s a little bit complex because gas prices are essentially influenced very strongly by US shale gas. And US shale gas can be produced at a reasonably low level, but about 30% of the gas production last year was associated gas coming from crude production.
What are the renewable energies you are most bullish on in terms of your trading capacity and their market penetration? How is Mercuria working to be the trading force in these emerging energy spaces, I’m thinking particularly of power storage and hydrogen.
Whatever people say, renewables have not been that profitable without some form of government intervention. So the renewables started becoming competitive compared to hydrocarbons somehow last year. And then obviously, with the price collapse of oil and everything, renewables are going to need some help. And I think they will get help depending on political sort of direction given, I think Europe is going to give help to renewables…we’ll see what happens in the US and Asia.
If you look at the price of power for the last x amount of years in Europe or in the US, you see, okay, the cost of putting my solar panel, but putting my wind power generation, it’s going to be sold. And if I can sell it at that price, I’ll be making a profit. So either prices have to be somehow guaranteed by state or guaranteed by utilities, someone has to guarantee you that price, in which case you can make an investment or if there is not such a frame, you have to just take the risk. But if you look at power prices, in – for instance, in Germany, they very frequently go negative.
If you build a renewable capacity and have to sell occasionally your part at [a negative price], you’re not going to be able to sustain those kind of investments. So someone needs to come and help you — to understand your risk and maybe to help you hedging that risk or reducing that risk. And I think that’s again a function where we can clear a role, and we do this in the US in Texas, prices also go negative on a regular basis, therefore we think we have a role to play in that, we’re trading power, renewables in the US and Europe and trying to contribute in that.
What do you see as the most promising asset classes arising out of the energy transition, and are you looking at new areas – hydrogen a tradeable fuel, for example?
We don’t normally go for cutting-edge technology because we don’t think we have competitive advantage. We don’t have geophysicists. We don’t have a super technician. We don’t have physical scientists, nuclear scientists. We’re not on the research front of things. Our job is to facilitate the entry of new technology into market or to bridge the gap in prices.
At some point, if hydrogen demand starts picking up, clearly, there will be a link between hydrogen and different parts of the energy sectors and potentially with gas, we’re using a pipeline to transport it. And we do have commitments on US pipelines, for instance, we do have commitment on European pipelines. So we will help the development of it, but it has to have reached a certain maturity level.
We see every day what real demand, real supply is, and we can bring the reality check when someone comes with a new idea, to say this idea is brilliant, but you have to wait a bit more.
Do you see opportunities in products like copper, iron ore or some of the battery metals driven by Asian demand, similar to what we had in 2008?
We see a decent chance to have certain support for market recovery, that China is going to need more iron ore to build. So are we going to see a spike to the level we had before. My guess would be no, but I think we’re going to see higher price potentially then prepended, and they’re going to be reasonably well supported.
Would you look to bulk up your business in areas like iron ore as a consequence of that?
We’re not a large player in iron ore, but we’ve been present in iron ore, probably for the last three or four years. And I think the size we have in those markets and is satisfactory to us. I don’t think that we need to feel that we need to early build up a lot more. I think we’re happy. It’s not unusual for us, but sometimes, we’re happy to be a small player in a big market.
Do you see a risk of structural slow down in global growth and a potential retreat from globalization as a result of the pandemic?
I don’t think the pandemic itself is going to change much in that. I think what may change is the international relationships. We can see that there’s some tension building up between the US and China, we can see tension between Australia and China. So I think it’s going to be more driven by political changes than by the pandemic itself. I think what we’re going to see, in my opinion, a recovery – economic recovery, maybe faster than most people anticipate.
But at the same time, I think there’s going to be winners and losers. So it’s more within society, within countries that you’re going to see some people suffering a lot more than others. The winners, obviously, will be the tech companies. And I think the mid- to small-size businesses, which are leveraged, going to be least struggling to come out of this. So it’s more a reshuffling within country than the reshuffling of the world order.
Going forward, there has been some talk that what we’re actually seeing now is peak oil in demand around 100 million barrels plus. And that’s come out of an economic change globally that may arise from the pandemic. Where are you seeing the top of the market demand wise for oil? Do we go to 110, 120, 130? Or are we getting to the end of that cycle?
To be honest, I mean, the recent move into demands and pandemic or whatever, has humbled me a little bit into making prediction about anything. I’ll certainly not want to make predictions five years down the road because it’s going to depend on prices eventually. Price dictates more things. So if renewables can come cheap enough and compete with energy prices coming from fossil fuels, maybe we have seen the peak. I’m certainly not going to venture to make a five-year forecast about anything because it’s hard enough for me to predict what will happen this afternoon, let alone tomorrow.
How much of a worry are widespread industry spending cuts this year in response to sharply lower oil prices?
This is the biggest reduction in investments in our history. Clearly, that’s going to have some impact at some point, not immediately because producers like OPEC, low-cost producers still have rooms to actually increase production by quite a bit. So there’s still spare capacity available at kind of affordable price.
But eventually, if you need the shale industry to come on stream, you’re going to need higher prices. And therefore, the lack of investment will, in our opinion, undoubtedly have an impact on medium-term price, and we’re going to see them at a higher level to justify the investment necessary to produce more from the shale perspective.