What's Next For Oil As Prices Go Negative - OilPrice.com

What's Next For Oil As Prices Go Negative - OilPrice.com


What's Next For Oil As Prices Go Negative - OilPrice.com

Posted: 20 Apr 2020 12:00 AM PDT

Oil prices crashed through zero, closing out the day at -$37 per barrel, an unprecedented meltdown.

There are mitigating circumstances to these insane numbers. The prices for WTI reflect the contract for May, which expires this week. The collapse is a reflection of traders abandoning the May contract, and moving on to June. The thinly-traded May contract loses some relevance, and analysts say that the June contract – trading at $20 per barrel as of Monday – now becomes the important number to watch.

Nevertheless, it is hard to ignore the historic numbers flashing across the screen. As futures contracts expire, they tend to converge with the realities of the physical market. Prices went negative because the physical market in Oklahoma and Texas is so overwhelmed. OPEC+ did agree to historic production cuts, but not for April. In any event, the cuts pale in comparison to the decline in demand. But taken together, the effects of the price war on the supply side are colliding against the depths of demand destruction at the same time.

The result is really ugly. Nobody wants physical delivery of WTI for May, and with storage options dwindling in some places, traders liquidated their positions, selling contracts at crazy discounts. With the contract expiring on Tuesday, nobody wanted to be left holding the bag. Unable to actually accept physical delivery, traders ended up paying someone to take oil off of their hands. Surely, some fascinating reportage will be written about the last guy that got stuck with an unwanted May contract.

"The intraday WTI destruction today is certainly epic in scale, which is largely a case of jitters ahead of the WTI May 2020 futures contract expiring tomorrow and storage fears finally materializing," Louise Dickson, Oil Market Analyst at Rystad Energy, said in a statement. "But if you have been watching the physical spot prices in the North Sea, currently trading in the $15-18 range, this drop in WTI May 2020 futures isn't as shocking."

On the one hand, the negative pricing will be chalked up to a weird one-off glitch, a confluence of historic firsts due to a price war, pandemic and downward economic spiral. The bizarre development may quickly be forgotten as traders move on to the June WTI contract, which is trading at $20 per barrel. But while June doesn't appear quite as catastrophic, oil at $20 is not a price at which most oil companies can survive for any lengthy period of time. Moreover, there is no reason to think that $20 is the floor.

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The second quarter is "likely to be the most uncertain and disruptive quarter that the industry has ever seen," Schlumberger CEO Olivier Le Peuch, said on the company's earnings call last week.

On Monday, Halliburton also offered a grim outlook for the oil market. "We expect activity in North America land to sharply decline during the second quarter and remain depressed through year-end, impacting all basins," Halliburton's Chief Executive Officer Jeff Miller said in a statement. The oilfield services giant reported a net loss of $1 billion in the first quarter.

The oil rig count dropped by another 66 last week, another steep reduction. The Permian basin lost 33 rigs. Production declines have already started, but more shut ins are necessary in the short run as spot prices come under tremendous pressure.

Ultimately, the market continues to be at the mercy of the pandemic. Several billion people are living under some version of a lockdown. The hits keep on coming. Demand for road fuels in India has plunged by 50 percent, for instance. Analysts have repeatedly revised oil forecasts, with an increasing recognition that the shock to demand will be lengthier than previously expected. In April, at least, demand will be down by 29 million barrels per day (mb/d).

Those staggering figures may not be quite as large in May and beyond, but there is little chance that global demand bounces back to 100 mb/d anytime soon, if ever. Mark Lewis, global head of sustainability research at BNP Paribas Asset Management, argues in the FT that we may have just witnessed the permanent peak in oil demand. Greater efficiency, more EVs and also permanent changes in behavior stemming from the pandemic could add up to a peak in consumption.

By Nick Cunningham of Oilprice.com

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The Death Of U.S. Oil - OilPrice.com

Posted: 28 Apr 2020 12:00 AM PDT

It's game-over for most of the U.S. oil industry.

Prices have collapsed and storage is nearly full. The only option for many producers is to shut in their wells. That means no income. Most have considerable debt so bankruptcy is next.

Peggy Noonan wrote in her column recently that "this is a never-before-seen level of national economic calamity; history doesn't get bigger than this." That is the superficial view.

Coronavirus has changed everything. The longer it lasts, the less the future will look anything like the past.

Most people, policy makers and economists are energy blind and cannot, therefore, fully grasp the gravity or the consequences of what is happening.

Energy is the economy and oil is the most important and productive portion of energy. U.S. oil consumption is at its lowest level since 1971 when production was only about 78% of what it was in 2019. As goes oil, so goes the economy…down.

The old oil industry and the old economy are gone. The energy mix that underlies the economy will be different now. Oil production and prices are unlikely to regain late 2018 levels. Renewable sources will fall behind along with efforts to mitigate climate change.

It's Really Bad

2020 global liquids demand may average 20 mmb/d less than in 2019 (Figure 1). This estimate is really a thought experiment because it is impossible to know what supply and demand are in the present much less in the next quarter or beyond. This is a time of unimaginable flux and uncertainty because no one knows how long economic activity will be depressed, how long it will take to recover or if it will recover.

The estimate in Figure 1 differs from most forecasts in two important ways. First, I believe that supply will fall much faster than most other sources. That is because storage will soon be full and shutting in production will be the only option for many producers.

Figure 1. 2020 global oil demand may average 20 million barrels per day lower than in 2019.

Source: OPEC, IEA, Vitol, Trafigura, Goldman Sachs and Labyrinth Consulting Services, Inc.

Second, I doubt that there will be a demand recovery in the third quarter despite the re-opening of businesses in the second. That is because we are in a global depression. Unemployment will remain high and consumers will be damaged from lack of income over the months of quarantine. The truth is that I doubt that demand will ever recover.

Economies will re-start slowly. A useful analogy is being at a traffic light behind 25 stopped cars. The light will change from green to red before your car begins to move. It may take several light changes before you get to the other side of the intersection.

U.S. consumption has fallen about 30% from 20 mmb/d in January to 14 mmb/d in April. Refinery intakes are already 25% lower than in the first quarter of the year and will fall further as consumption decreases. Refineries will close.

Most U.S. refineries require intermediate and heavy crude oil that must be imported. Few U.S. grades of oil can be used to produce diesel without blending them with imported oil. That is because they are too light to contain the organic compounds need to make diesel. Redesigning refineries will not change this.

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The world's natural resource extraction, shipping and distribution system relies on diesel. As refineries close and less diesel is produced, there will be lower levels of natural resource extraction, less manufacturing and less buying of goods.

Diesel cannot be produced without first producing gasoline. The U.S. has had a gasoline surplus since late 2014 and the current surplus is the highest in 5 years (Figure 2).

Figure 2. U.S. gasoline comparative inventory has increased 30 million barrels since March 20 to a record level of 28.4 million barrels more than the five-year average.

Source: EIA and Labyrinth Consulting Services, Inc.

Diesel demand is less elastic than gasoline demand because of its critical role in heavy transport. What will happen to the excess produced gasoline if storage is full? Will it be burned?

Those who see an opportunity for renewable energy in the demise of oil need to think again. The manufacture of solar panels, wind turbines and electric cars depend on diesel all along the supply chain from extraction to distribution of finished products. A world in economic depression will default to the cheapest and most productive fuels. Oil will be cheap and abundant for a long time. There will be little money or appetite for the massive equipment changes that renewable sources require. Climate change will not be high in the consciousness of people struggling to survive.

Figure 3 is another thought experiment in which I use tight oil rig count and output to estimate forward levels of U.S. production. The normal trajectory is an estimate of how production might decline as rigs are idled from lack of capital investment. It suggests that tight oil production might decrease by about 50% from 7 to 3.5 mmb/d by July 2021.

Figure 3. Thought experiment based on rig count through April 2020 and 12-month lagged production.

Source: Baker Hughes, EIA DPR, Drilling Info and Labyrinth Consulting Services, Inc.

The shut-in trajectory suggests that tight oil production may fall below 3 mmb/d by June of this year. Since tight oil accounts for about 55% of U.S. output, total crude oil and condensate production could decline from 12 mmb/d to 5.5 mmb/d by the end of the first half of 2020. This estimate is much more aggressive than EIA forecasts because EIA hasn't adequately modeled the speed of shut in production with full storage levels.

Energy is the Economy

Gross domestic product (GDP) is proportional to oil consumption (Figure 4). That's because oil is the economy. Every aspect of production and use of goods and services requires burning fossil energy. There are approximately 4.5 years of human labor in a barrel of oil (N. J. Hagens, personal communication and The Oil Drum). No other energy source comes close to that level of energy density.

Figure 4. Gross domestic product (GDP) is proportional to oil consumption

Source: EIA, World Bank and Labyrinth Consulting Services, Inc.

Those who believe that the world will function the same on lower energy density sources like wind and solar should review their old physics text books. You cannot fit 4.5 years of work from sunlight or wind into the 5.6 cubic feet space of a barrel of oil.

Seventeen investment analysts recently estimated that U.S. GDP would contract an average of 30-35% in 2020 (Figure 5) within a range of 9-50%. The correlation shown in Figure 4 suggests it will decrease by about 20-25% based on estimated decrease in U.S. oil consumption. Any value within this spectrum is catastrophic.

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Figure 5. U.S. GDP to contract 30-35% in 2020 based on estimates by seventeen investment analysts

Source: Charles Schwab and Labyrinth Consulting Services, Inc.

Economist Lawrence Summers has warned that the U.S. financial system may collapse because of cascading defaults. Approximately 25% of U.S. renters did not pay their landlords and 23% of Americans did not make their mortgage payment in April. When people don't pay their creditors, creditors in turn cannot pay their creditors. For comparison, a 28% mortgage default rate contributed to the 2008 financial collapse.

Joseph Stiglitz recently explained that the current pandemic will affect the developing world more severely than it has developed countries. It might lead to mass migration problems that could dwarf the dislocations of the last six years out of Africa and the Middle East.

Slouching Toward Bethlehem

Many will probably find my analysis overly pessimistic. Crude oil markets do not. Negative WTI futures prices last week could not have sent a stronger signal for producers to cease and desist.

Large segments of the U.S. oil industry will have to be nationalized before the year is over. The price of oil is too low to justify the cost of extraction even if storage were available. The value of a barrel of oil, however, is 4.5 man-years of work and that productivity multiplier will be essential if the U.S. economy is to avoid collapse or for it to recover if collapse is unavoidable.

The United States has engaged in the foolish practice of draining America first since the beginning of tight oil production a decade ago. There was value up to the point that domestic oil substituted for imported light oil but exporting more was dumb. That is true especially now that someone else's oil will be cheap to buy for years.

There are few moments when we may truly say that things are different now. This is one of those moments. We do not know what awful form the future may take, what rough beast slouches toward Bethlehem to be born.

The game is over for oil. We should place all of our attention on saving the economy.

I hope that we learn to view what is happening as a chance to simplify and to learn to be satisfied with no more than what we need. It is unlikely that we will have much choice.

By Art Berman for Oilprice.com

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