The Worst Is Yet To Come for Oil Prices

Yves here. The spectacle of WTI oil futures collapsing to below zero before options expiration has been a harsh wake-up call to the industry. Producers haven’t cut output anywhere near as much as they need to in line with the sharp and unlikely-to-change-much-soon plunge in demand.

And there isn’t all that much oil storage. This issue was a topic back in 2008, when oil prices spiked to $147 a barrel and observers were closely watching oil inventories. The point we cribbed from Dan Dicker at back then still holds:

…in the world of energy trade, there is lack of fungibility that has always broken down thus: Electricity, non-storable — Natural gas, more storable — Crude oil, mostly storable

Although easiest of the three, oil storage has been historically inelastic, no matter the price… Over the last 4 years (and for most of my trading life) forward stocks have always hovered between 50 and 55 days — storage is expensive and limited, and just not efficacious.

This is why, at least in my view, that supply arguments are often overblown in oil pricing theory — supplies remain closely aligned to demand and rarely overrun — as OPEC members have time and again explained but are ignored. This is why President Bush can walk in to a meeting with Saudi ministers and be patted on the head like a silly schoolboy — “you don’t understand, Mr. President — we’ve got nowhere to SELL any more right now” and Bush will run home and talk about increasing domestic supply as if he hasn’t heard a thing

Now we’re seeing what happens when supply does overrun demand. The crunch came fastest and hardest for WTI, since storage at Cushing, Oklahoma, where oil traded in under the WTI contract is to be delivered, is generally limited and is now full. A Financial Times reader pointed out what happens when oil future contracts expire:

To ensure orderly functioning of the market, the futures no longer trade, but the contracts still exist, but you can only hold the contract in the last month if you have proof of storage. This means all non-commercial players have to get out, which is precisely what happened yesterday.

By Nick Cunningham an independent journalist, covering oil and gas, energy and environmental policy, and international politics based in Portland, Oregon. Originally published at OilPrice

Dashing hopes for some oil producers who may have thought negative prices were a weird quirk, the June WTI contract fell sharply on Tuesday.

During intraday trading June contracts collapsed by more than 45 percent, falling close to $11 per barrel. The selloff demonstrated that the ruinous supply glut is not going away, and that the meltdown for the May contract was not just a bizarre anomaly, but representative of an acute state of oversupply in North America.

In fact, there could be a rerun of negative prices in a month’s time, according to several analysts. “We believe prices are likely to remain at basement levels in the short-term with further shut-ins forthcoming – expect late-May to bring similar price movements as the June contract rolls over,” Raymond James wrote in a note on Tuesday.

The malaise bled over into Brent prices, which collapsed below $20 per barrel by midday Tuesday, down more than 25 percent.

While forecasts have suggested that U.S. oil production could fall by 1 or 2 or 3 million barrels per day (mb/d) by the end of 2021, depending on who you ask, the lack of storage and collapsing prices means that shut ins could begin to mount very quickly. “[T]he physical reality of a still massively oversupplied oil market will likely exert downward pressure on the June WTI contract,” Goldman Sachs analysts wrote on Tuesday. “But with ultimately a finite amount of storage left to fill, production will soon need to fall sizeably to bring the market into balance, finally setting the stage for higher prices once demand gradually recovers.”

“This inflection will play out in a matter of weeks, not months, with the market likely forced to balance before June,” Goldman analysts warned. In other words, the U.S. oil industry could lose several million barrels per day in the next few weeks in what Goldman analysts called a “violent rebalancing.”

The crisis for the industry has entered a new phase, which will surely provoke more twists and turns. The Trump administration, flailing about, is trying to come up with ways to bailout the industry. On Monday, President Trump suggested that he would consider halting imports of oil from Saudi Arabia (“We’ll look at it”), while also reiterating his plan to fill up the strategic petroleum reserve with 75 million barrels of oil.

On Tuesday, he tweeted that he ordered the Secretaries of Energy and Treasury to come up with a rescue plan.

Also on Tuesday, the Texas Railroad Commission punted on the idea of mandating production cuts. Two of the three commissioners were uneasy with the idea of voting on the proposal. Ryan Sitton, the one commissioner in favor of requiring a 20 percent cut in the state’s production, argued that not voting was itself a decision, allowing the market to mete out production cuts in a disorderly fashion. “I don’t believe that inaction on our part is acceptable,” Sitton said.

Meanwhile, there are other ideas for government intervention. The oil and gas industry is lobbying the Federal Reserve to loosen its $600 billion lending facility to allow drillers to use funds to repay debt, according to Reuters.

In addition, the “Treasury [Department] could guarantee loans to distressed firms in return for equity stakes or senior debt, and Washington could use its voting shares to compel shut-ins (i.e., as part of a bargain with OPEC+),” ClearView Energy Partners wrote in a note to clients.

While the oil market drowns in oversupply, there also seems to be a glut of unusual policy responses coming from Washington aimed at bailing out the industry.

But in the face of demand destruction on the order of 25 to 30 million barrels per day (mb/d), there is very little that the U.S. government can do to head off steep production losses and bankruptcies.

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  1. Glen

    It continues to amaze that the US government will spend TRILLIONS to prevent bankruptcies, and a pittance while citizens starve.

    1. JBird4049

      And even before the quarantine the real economy as opposed to the financial/stock market economy has been increasingly sputtering for decades. I know that the official statistics say that the economy was going good, or at least employment was tight, but I am not seeing it. Even in areas with labor shortages wages have not matched the increase in the cost of living for decades.

      I agree that if the government, and society in general, focused on increasing the welfare of the population by whatever means necessary including direct payments or bringing at least some of the industries that the United States used to have would increase the real economy, which would reduce the need to spend trillions propping up companies. But that’s socialism.

  2. PlutoniumKun

    Much as it gives me pleasure to see the pain of the oil and gas industry and to see a huge drop in demand for the black poison, hastily abandoned oil and gas wells are potential slow motion environmental catastrophes. Capping a well properly is a skilled task, and it’s expensive. It gets even harder and more expensive to do if the well is just abandoned with a crude concrete plug where the platform used to be. From the point of view of climate change, there is an arguable case to be made that thousands of poorly capped abandoned gas frack wells is even worse than active frack wells, as unburnt methane is more potent and efficient in the short term for heating up the planet.

    As to the supply issue, the big problem for the US in contrast to Saudis and Russians, supply is provided by dozens of competing companies, all of which are desperate for cash flow to keep their heads above water until something rescues them, whether it be a bail out or a war somewhere that causes prices to spike (don’t tell me the latter option hasn’t occurred to some of them). So there is zero incentive for any one operator to cut back on production, even at below cost prices (as the marginal cost per barrel of producing oil or gas is usually very low for existing wells). So it will be far harder than many imagine to make serious reductions in supply. They will keep pumping until someone, or something, stops them.

    1. fajensen

      I think following the collapse of the USSR, one of the lessons was: What used to be an advantage in the ‘old system’ often becomes a disadvantage in the ‘new system’ the flip-side of that coin is that a disadvantage in the ‘old system’ often becomes an advantage in the ‘new system’.

      Thus having oil well when nobody needs lots of oil is now a disadvantage, but, having a good deal of efficient drug-smuggling infrastructure with armed escorts available in place may become an advantage when it comes to shipping PPE without Kushner applying ‘The Patriot Act’ to steal them:

      1. rd

        It may not matter. Telling people they can go to the office, restaurants, bars, concerts, and cruise ship vacations is not the same as people actually doing it.

        I predict our family will be using a lot less gasoline over the next 12-24 months regardless of what the President, governors, and mayors say. We might move up to two gas tank fill-ups per month instead of one, but that is very different than the eight to ten we were doing before.

        I did about 50-60 flight segments on three airlines last year. I had 12 before end of February. I may do 4 or 8 from March-December this year and that is if things go well.

          1. Conrad

            A decent pair of clippers suffices for the males in our family. Number 1 all over is good for lice suppression as well when the kids get nits.

  3. Adam1

    In the early 1990’s I was attending college in Buffalo, NY. I grew up just down the I-90 in central NY just a couple hours away. During my stay there I was amazed that gasoline prices were always about $.20 lower – mind you at that time it was almost a 20% discount. I finally commented on the observation to my father who at the time was a regional executive for Amerada Hess on the retail side of the business. Without hesitation he said well Buffalo is at the end of a refined products pipeline that comes out of NJ and they get stuck with any excess inventory which locally weighs on their prices.

    1. rd

      That price discrepancy still persisted through last year, although I don’t what it is right now. You always fill up east of Rochester.

      1. albrt

        Similar multi-decade situation in the area between Dayton and Lima Ohio. Drove through yesterday and several stations had gas at 99 cents. An hour north it’s at $1.35.

  4. Wukchumni

    Here we are on the verge of Max Mad with idiots of biblical proportions in the red states clamoring to be infected, and there’s so much oil we don’t know where to put it…

    If you would’ve suggested this plot to me a year ago, I would’ve thought it was one of those Hollywood films where suspension of disbelief was a must in order to watch~

    The collapse scenario keeps unfolding, and I hope you all have at least 6 months worth of food on hand and preferably a years worth, this is no drill.

    1. ejf

      Yup, Wuk, “…this is no drill”. That got me thinking. It sounds like we need an event: another Gulf of Tonkin, a confusing consortium of terrorists, something… We all rally around the cause for revenge, the idiots dissipate, bored 18 to 24 year olds sign up to serve, the oil market is saved. And the Dems go for it again.
      Then again, that only works if the virus doesn’t kill us first.

  5. Sound of the Suburbs

    The Powell Memorandum 1971
    Right wingers weren’t very happy as they were surrounded by Keynesian, left wing thinking.
    They came up with a cunning plan to get right wing thinking back into our institutions.

    Let’s hope that right wing thinking isn’t the same load of old twaddle they used to think in the 1920s.
    It was.

    When the New Deal and Keynesian thinking came in, right wingers got into a real strop and wouldn’t accept there was anything wrong with their ideas.
    If they had taken on board the problems that were discovered in the 1930s and 1940s, and updated their thinking, they would be in a lot better position today.

    In fact we would all be in a lot better position today, as we all have to face the consequences.
    The sneaky little devils wrapped their old ideas in a new ideology, neoliberalism, which they rolled out across the world.
    They bolted on identity politics to attract liberals towards old right wing economics.

    A master stroke.

  6. TiPs

    I certainly won’t be surprised if trump bails out the energy sector, as it’s also a backdoor bailout for Wall Street, with (the last time I checked) over $100 billion in loans outstanding…

    Of more interest to me is the impact the price collapse is having on oil ETFs like USO. Will it collapse? Isabella Kaminska has written a couple pieces. There is a very weird “financial dynamic” going on with it. Crashing oil prices are wiping out its NAV, yet retail investors have created a nice little money machine by pushing the ETF price to a significant premium. As of yesterday, NAV was $2, and the ETF price was $2.80, a 36% premium. I thought that the price crash would push USO to the brink as their cash gets eaten in the margin account, but they seem to have “re-supplied” their cash position by selling shares from inventory. While NAV lost $1 billion yesterday, shares outstanding went up by about 400 bil, which added a billion to their cash holdings.

    Seems to me this is a perfect example of how Wall Street takes advantage of “dumb” investors…

    1. Shiloh1

      It’s all a Wall Street Bailout, anywhere and everywhere, directly and indirectly. Schiff and Gammon called the bank, corporate and local, state and federal government debt collapse in easily found YT videos in November 2019.

      Never let a good crisis go to waste.

      1. flora

        The Wall St. bailout as constructed looks like a replay of 2008 – throw money at Wall St and the tbtf banks with no strings attached. It’s the ‘no strings’ part I find problematic. Then as now, keeping the banks solvent, the derivatives markets and commercial paper market from seizing up, and Wall St. from crashing was important. If Wall St and its components of banking and energy sectors had collapsed it would have taken down pension funds and 401k savings with it. It would have seized up the world commercial paper market. Wall St finance has become a tangled snarl of counter parties and negative feedback loops, a vicious cycle.

        Companies borrow money to buy back their stocks to pump up stock prices. That’s simple looting and stock price fraud on the one hand. It also increases the financial condition of big pension funds and 401k’s who own those stocks on the other hand.

        This Wall St/pensions/commercial paper connection is the Gordian Knot. How to regulate Wall St. toward sanity and productivity; how to enforce anti-trust law in the face of ‘monopolies are profitable and good for stockholders’ thinking; how to deflate the Wall St. bubble without crashing everything is the problem. It needs to be done. How to do that….? Well, slowly, part by part, to avoid a sudden seize up. The bailouts should come with strings attached designed to curb continued abuses. They should come with strings, but this time like 2008 they aren’t. My 2 cents.

        1. Amfortas the hippie

          but who will fashion those strings?
          and who will wield them?
          that’s the big problem…no Opposition Party to Big Capital…just the Junior Partner in rapine and plunder, with a care for gay people.

          to keep the current grandest larceny going because of pensions(aren’t those a thing of the past?) and 401K’s(a skin in the game tactic to keep exactly this argument in people’s minds) is getting harder and harder to contemplate.
          the incestuous and pernicious entanglement of FIRE into every corner of the “Real Economy” can not likely be undone pragmatically, carefully or even sanely.
          The Money Men have inserted themselves into everything, thus preventing their removal.

          My grandpa used to say something along the lines of :” if the rats get too bad, sometimes you just have to burn the barn down and start over”>

          remember, if you have the wherewithal, to run out and purchase a pitchfork Friday-Week…donate it to a food bank with a garden, or something.
          it’ll show up in somebody’s ledger.

    2. rd

      I experimented with small amounts of a couple of these ETFs 10 years ago just to see what the ETF fuss was about. It quickly became pretty clear that they were just a license to print money for the ETF companies. The contango and backwardization issues were one factor. Also, they roll into the next months contracts on a schedule and the professional traders trade against that schedule. Basically, these types of ETFs are designed for day trading but are pretty useless for holding periods longer than a couple of days. GLD actually buys physical gold and holds it, so it actually has a real NAV. All the others are just poor cousins in the futures markets.

      ETFs are useful for stocks and bonds, but are not of much value for commodities.

    3. drumlin woodchuckles

      IF! . . . such a coal/gas/oil industry bailout needs Congressional action, THEN! . . . this is an opportunity for Senator Sanders to show he is willing to excercise power by placing a Senatorial Hold on any such legislation until it is written to include a total and concurrent bailout for all impacted State, City, County, Municipal, etc. governments at the same time. He has the power to exTORT this bailout from the Senate as his condition for permitting a Fossil Carbon bailout to go forward.

      It will be his moment, if he dares to rise to it.

      Naturally, not one single Catfood Democrat Senator would do such a thing. And every Democrat is a Catfood Democrat.

      So it would be up to Senator Sanders, or nobody at all.

  7. Logan & Mao

    The oil & gas industry, if you think about it, is already quasi nationalized but not in a “for and by the people” populist egalitarian kind of way. It’s nationalized in the sense it has largely been protected from risk by the government so that said risk never affects the shareholders’ ROI. The oil and gas industry is a quasi government organization in a fascist sort of way. In fact, it’s inverse fascism meaning the oil & gas industry, the companies that comprise the consortium, have captured the American government to the point the American government does its bidding in any and all things.

    In Italy and Germany during the first iteration of fascism in the early part of the 20th century, it was the government of those respective countries that initiated the union of private corporations and government and it was the government that was the power player in that equation and the government held the balance of power. In this latest early 21st century form of fascism, it’s the other way around in this unholy alliance of corporation and state. It’s the corporations that hold the balance of power. For now, but the arrangement is tenuous at best all things considered.

    This novel (is it ever) virus may soon prove to be a second Maoist revolution in that it may ultimately expunge the majority of the geriatrics to make way for the younger generation. Think of it as a sort of Logan’s Run scenario sans the celebratory ritual that accompanied a human’s deactivation per that prescient and pertinent story.

    1. Eclair

      Oh, really, Logan & Mao, stop with the geriatric bashing splitting off the working class so we attack each other. I have a group of women friends (comrades?), all over 65, union members, well-read in non-violent protest methods, medicare-for-all advocates, climate activists, pissed as hell with the last couple of decades of ‘leadership.’

      And, do you really believe that the spawn of the current oligarchy, legacied and bribed into comfy berths at Harvard, Yale, USC and Stanford, are going to join your ‘younger generation?’

      Apologies for sounding testy.

  8. Steve Ruis

    In one of the comments (TiPs) this was said “I certainly won’t be surprised if Trump bails out the energy sector, as it’s also a backdoor bailout for Wall Street, with (the last time I checked) over $100 billion in loans outstanding…”

    It seems that one way to support industries under such circumstances is for the government to buy out all of those loans (maybe we can get them discounted). Then suspend payments for the duration of the crisis. Then collect payments when business picks up again. Eventually we get our money back.

    But is seems that the current GOP administration is more in favor of just giving the money away. These seems not to be applying “good business practices” to government, which was a scam in the first place.

  9. ptb

    The drama level is apocalyptic for traders. Most producers and consumers, however, are priced on a longer timeframe. For a more sober analysis, skip the discussion of the spot or front month, and look at the entire strip.

    Jan 2022, for example, has the WTI at around $35, down from the $50-$60 range in 2019. That is the number to look at for the “future” of the industry.

    Of course $35 is disastrous in itself. Knocks out most US unconventional production, for starters. But they will simply return at a later time. As long as shale wells with their ~1 year timelines are the marginal producers, world production can respond easier (both up and down) than in prior generations, when the marginal producers were billion dollar undersea complexes.

    On the timescale of the conventional players, the US pulling the plug on some fracked wells will produce lower overall losses, and similarly, the barrier to restart (capital required) at an unspecified time in the future is far lower. As mentioned, the US govt will subsidize as necessary, with unlimited funds.

    The effect on the finances of the high impact international players, might be more interesting. Who will provide the bailouts – US vs China, etc.

    1. rd

      They still have hope. The uncertainty is whether or not people will be driving and flying something like normal 6 months and a year from now, so the pricing a year or two out is still relatively high compared to today. But it could start to ripple out. If entities have hedged their fuel by buying a bunch of future production (e.g. airlines) that they won’t use, they will likely sell those futures at a substantive loss down the road. Depending on the quantity of futures sold, continued pressure on storage means there would be a lot of futures out there producers are planning on selling but the buyers may have no place to put it.

      The past few days are a shot across the bow of what might be coming in the summer and fall if the current energy use trends continue for a few more months. Even the futures going out a year or two are low enough that they are telling a number of firms not to drill and the layoffs are starting. Other than the Fed, I don’t think there are a lot of junk bond buyers for the capital that the fracking firms need to do their wells.

  10. vegeholic

    Unfortunately, the administration is going to spend trillions to “make things like they used to be”. This is a fool’s errand. We have taken a big step down and we will not be going back up to the previous level. We should target investment to what will be needed in a future of lower prosperity and therefore less energy usage. Rehabbing and reinvigorating the rail system (including passenger), rethinking suburban land development patterns, reintroduction of manufacturing, diversifying agriculture, and encouraging local supply chains. Likely the wisdom of these actions will only become apparent after all the money has been squandered on propping up the unsustainable.

    1. Dita

      The transition to alternative energy and fabrication and manufacturing will take years, beyond the rest of my lifetime for sure. I just don’t see a scenario where that would *not* be the case, and what we have been experiencing is part of the process. Right now, demand destruction from oversupply/lack of commercial activity or later from prohibitively high prices, but people will not choose voluntarily to forego their online use, tech doodads, personal products, and so on. Society rests in a petro framework, so IMO there can’t be anything like a smooth transition, instead it’s going to be extreme and probably deadly, over several generations.

      1. Ian Ollmann

        Nah. Renewables are already a sizable chunk for many states, including many red states, and it is still ramping up. The last (guess?) 20% will undoubtedly prove harder to get rid of, but in time we can make large battery installations and other storage mechanisms.

        The good news is that all this staying at home has done more basically over night to eliminate CO2 production than anyone could have imagined we’d achieve in a decade or two. Nobody would have proposed a 95%+ reduction in air travel, but that is where we are. Cars are way down too. Maybe some highway spending could be redirected to green spending.

        That is really the important part. As we dig our way out of this problem we should be sure that we invest in green tech.

    1. Tom Bradford

      It’s going to end up costing a lot more than a cent if Iran shoots back – tho’ that may well be the idea.

  11. Aloha

    I am trying to get my head around the price of oil these days and have a (dumb?) question. The US dollar used to be backed by gold and is now called the “petro dollar” because it is backed by oil sales. Other countries have to buy their oil in US currency and I have read that one reason the US wants to take over Iran and Venezuela is because they are refusing to use the US $ in sales.
    My question is if the US dollar is backed by oil and oil has plunged, why hasn’t the dollar plunged along with it? (My guess is that the Fed is artificially keeping it up along with the stock market)

    1. TroyIA

      Short answer is that there is a global shortage of USD. Countries around the world have borrowed in USD and all are scrambling to find dollars to repay their loans. Watch the dollar index to continue to strengthen and foreign countries to spend their reserves before defaulting. In other words global deflation possibly leading to unstable countries reaching such desperate times that conflict or war could result.

    2. Yves Smith Post author

      The petrodollar is a myth. Stop propagating it.

      We have explained REPEATEDLY that the dollar is the reserve currency because the US is the only large economy willing to run sustained trade deficits, which is tantamount to exporting jobs.

  12. John k

    The Saudi 10mmb/day cuts are obviously inadequate with a 30mmb/day demand destruction- but that cut in Asian production is not relevant to North America anyway, Eurasian producers pretty much serve Eurasian refineries.
    The us became a net oil exporter for the first time in over a half century last fall. With demand down 30% and maybe not now exportable, the us must cut 5-6 mmb/day… our 700 mmb strategic reserve is 90% full, so us surplus can go there for just two weeks.
    I guess the portion (50%?) of fracked oil that is hedged will be produced and delivered to refiners under contract… producers would continue with the rest at almost any positive price bc they’re desperate for money… but not at a negative price. And $10 at Cushing means negative at most wellheads not served by pipeline. But shutting in the unhedged fracking production maybe not enough to close the gap… big traditional oil likely have to cut, too. It may take a negative price at Cushing to bring production into balance unless and until demand comes back. Yes, oil producing states soon to be screaming to open up.

    I was an avid reader of the oil drum back in the naughties… were not living in the world we all thought would exist in 2020.

  13. JakSiemasz

    Wow! The coronavirus is going to save the fracking industry. The industry was DOA before CV-19 and the virus has provided an excuse to bail it out. The good old USA, courtesy the Dumpster, will provide funds to these zombie companies and enable them to pay back their loans and keep the rentiers who put money into them whole! Well, probably not whole, but salvaged….best estimates put the industry’s debt at about $200B. What luck for these guys…management at the zombie companies will continue to get their grossly exorbitant salaries and their creditors will get repaid to an extent….. creditors of these companies pre-CV19 could expect ZERO return.

  14. Adam Eran

    One historical note: Daniel Yergin’s history of the oil industry (The Prize) notes that at no historical time was the price of oil *not* managed by some entity other than the market. Whether it was monopolist John D. Rockefeller, the Texas Railroad Commission, the Oklahoma Corporation Commission, or Harold Ickes office during FDR’s administration, prices were *always* managed. OPEC (a cartel) does the job now, but those TX and OK commissions are still managing prices too.

    The bizarre circumstance in which we currently find ourselves is that the U.S. institutions have suffered literally generations of attacks by the “anti-collectivist” market worshipers like the Kochs and others, so their regulatory clout and intelligence is much diminished. The clumsy flailing occurring now is what happens when you have a managed price, then de-legitimize the managers!

  15. Tom Bradford

    …in the world of energy trade, there is lack of fungibility that has always broken down thus: Electricity, non-storable

    Not true. Pumped-storage is a way of ‘storing’ electricity, using cheap electricity when conventional powerstations cannot help but produce it to pump water into lake above a hydro-station for release back down through the turbines when demand ramps up:

    In a sense any lake-based hydro-electric scheme could be regarded as ‘storage’, with the lake filling naturally when there’s no demand but coming on-line quickly when required.

    Too, battery technology in electric cars is replacing the need for gas in a tank, with the electricity to fill it coming from renewables.

    All it would take is the political will, to make electricity as fungible as oil or gas.

    1. baldski

      Some years ago, I read about a plan in Germany to use air compressors to pump air into an abandoned mine during the day using excess solar generated electricity and run air powered turbines at night to supplant the solar. Have not heard anything about it since.

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