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 TheStreet.com 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.
We will never let the great U.S. Oil & Gas Industry down. I have instructed the Secretary of Energy and Secretary of the Treasury to formulate a plan which will make funds available so that these very important companies and jobs will be secured long into the future!
— Donald J. Trump (@realDonaldTrump) April 21, 2020
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.