Like most contemporary financial instruments, the crash in oil prices has one similar underlying factor, the Covid-19 pandemic. Undoubtedly, the pandemic has had an indirect effect on oil prices, however, by simply attributing this crash on the pandemic, one fails to critically substantiate the immediate cause. The forces of demand and supply have played a crucial role in the free flow of oil prices. When it comes to oil and gas, whenever there is more supply than demand, prices always drop and vice versa. Currently, there is very low demand for jet fuel since many airlines have had to take the painful decision ground their aeroplanes. For instance, South African Airways (SAA) has suspended its international flights until 31 May 2020, owing to travel restrictions.
Airspaces have been closed and manufacturing processes halted. According to the International Air Transport Association (IATA), demand for oil and gas in the airline industry dropped by more than 50% over the past one month globally. In Africa, the demand for gas is at its lowest in decades. Fewer people are flying and jet fuel consumption has dropped by more than 80% in Southern Africa alone. For instance, the number of passengers that passed through South African checkpoints this year were 78,376 compared to 1,896,802. This implies more than a 92% drop in passenger air travel.
In addition, there is glut of oil due to price wars. It is prudent to mention that at the beginning of 2020, The Organisation for Petroleum Exporting Countries (OPEC) and other non-member countries had an agreement to cut production in order to pop up oil prices globally. In March 2020, Russia together with Saudi Arabia and OPEC disagreed on production limits and Saudi Arabia increased production that started a price war among oil producing countries. This increase in production has caused oil storage facilities to fill to the brim. As a result, there was too much oil and far less demand and no places to store the oil.
In turn, it has led to a historic situation where the prices of oil futures reached sub-zero levels of US$ -36 per barrel. The lack of storage facilities led to panic selling of traders and hereafter the crash. ‘Petrodollar’ economies such as Nigeria and Angola will have very difficult times moving forward. Literally, these economies (producers) will have to cut production until demand ramps up again. As countries in Europe, China and some states in The United States of America (USA) try to reopen economies, it could take months before oil demand goes to its normalcy. Until this happens, oil prices are likely to remain in single digits to lows of US$20s.
So, how does this affect Africa? First, the oil and gas industry require a lot of up-front investments and there are massive amounts of debts involved. Further, there might be a lot of bankruptcies and distress in oil and gas companies. This reduction in oil prices is unprecedented and is a clear indication of how shaken the markets are. This means that the world economy has shut down and no one precisely knows the exact timeline when it will take to recover.
West Texas Intermediate May Oil Future prices.
Second, oil is a significant factor in Africa’s economy. Therefore, during these unprecedented times, there are expectations of extreme volatilities. When the longest ‘bull market’ came to an end in early March, what followed were interesting periods. Most African stocks experienced wild swings. Indices traded record lows and most mutual funds complained about how their long-term gains had been swept under in a matter of weeks. The Dow chart has a similar representation of what is currently happening – the great depression. The Federal Reserve has acknowledged that the world markets may be in a global recession. The timeline of how long this could last is unknown.
The fact that governments are spending billions of dollars to revamp businesses and very few billions on containing the pandemic could be the reason why we will be in these dark times for a longer period of time. A combined approach may be more sustainable, especially for Africa.
Ken is a Quantitative Trader with experience in investments, quantitative finance, financial modelling and algorithmic trading in Global Investable Markets (GIM). He enjoys using Bayesian Statistics, Time Series and Machine Learning in developing Robust consistent Alphas in Equities Market, FX, ETPs and Derivatives instruments. He enjoys deep dives in understanding High Frequency Trading infrastructures and improving how the African financial markets work. He holds a Bachelor's in Actuarial Science from Strathmore Institute of Mathematical Sciences : An Executive Program in Algorithmic Trading (EPAT) certificate in Algo Trading from QuantInsti : A current MSc student in Financial Engineering at World Quant University.