Oil Prices Threatened to Fall Below $20... DLS and Refining Stocks in Turmoil

Last Month 30-Day WTI at $20.09 per Barrel... Lowest Level in 18 Years

[Asia Economy Reporters Kum Boryeong and Koo Eunmo] As international oil prices plummet, the number of derivative-linked securities (DLS) entering the principal loss zone (knock in) is increasing. Along with this, domestic refining stocks are expected to incur massive losses, leaving investors distressed.

On the 31st of last month (local time), West Texas Intermediate (WTI) crude oil for May delivery closed at $20.48 per barrel on the New York Mercantile Exchange (NYMEX). The day before, on the 30th, it closed at $20.09 per barrel, marking the lowest level in 18 years.

Most oil DLS are designed so that principal loss does not occur unless the oil price falls below 50% of the reference price at issuance. Considering that international oil prices fluctuated around $50 to $60 per barrel based on WTI from last year until February this year, applying a knock-in level of 50% means the loss-triggering price is around $25 to $30 per barrel.

However, as oil prices have weakened to threaten the $20 level, the possibility of losses in oil DLS is continuously increasing. According to the Korea Securities Depository, as of the 30th of last month, the outstanding balance of oil DLS was 1.3743 trillion KRW. By underlying asset, WTI accounted for 920.9 billion KRW and Brent crude for 453.4 billion KRW. Notably, among DLS based on WTI, the outstanding amount of DLS with loss thresholds set between 45% and 55% reached 575.5 billion KRW (62.5%), and among DLS based on Brent crude, the outstanding amount with knock-in levels set between 45% and 55% was 397 billion KRW (87.6%).

The outstanding balance refers to the amount of DLS for which early redemption periods have been reached but the underlying assets such as oil prices have not met early redemption conditions, resulting in deferred redemption until the next evaluation. If the price of the underlying asset does not rise by the next redemption evaluation, the likelihood of loss on the outstanding amount increases. Of course, since redemption evaluations occur every six months, if oil prices rebound in the future, investors can redeem without principal loss.

As oil prices continue to fall, the number of early redemptions of DLS has sharply decreased. Last month, there were 65 cases of early redemption (in KRW), down about 60% from 155 cases in February. The decline in underlying asset prices due to falling oil prices prevented early redemption. Conversely, early terminations increased nearly fourfold from 90 cases in February to 351 cases last month.

Domestic refining stocks face the risk of massive losses. Hi Investment & Securities forecast operating losses for S-Oil and SK Innovation in the first quarter at 826.2 billion KRW and 953 billion KRW, respectively. In particular, operating losses in the refining sector are expected to be 921 billion KRW and 955.9 billion KRW, respectively. The deterioration in refining margins due to falling international oil prices and losses from crude oil inventory valuation are cited as factors worsening performance.

The demand slump caused by the novel coronavirus disease (COVID-19) has also been a negative factor for refining stocks. Demand for jet fuel and gasoline is expected to sharply decline in the first half of this year. If paradigms affecting mobility demand, such as remote work and telecommuting, continue to change, the growth in crude oil demand may not be significant.

Shim Subin, a researcher at Kiwoom Securities, explained, "The low oil price trend is inevitable to continue in the first half of the year. Especially with the COVID-19 spread lasting longer than expected, uncertainty about the improvement in crude oil demand is high, and with production competition among oil-producing countries starting, it is necessary to keep open the possibility that oil prices may fall below $20 per barrel within this month."