Various reports hit the news feeds today quoting a deliberately headline-grabbing statement by Paul Sankey, managing director at Mizuho Securities, in which he is reported as saying, “Oil prices can go negative.” That is, they could as a combination of Saudi Arabia (and Russia) flooding the market with increased oil and the market running headlong into COVID-19-induced curtailment of activity that is suppressing consumption, which combined will create the perfect storm of excess supply.
In reality, inventory levels are already rising.
CNN quotes Sankey, who said global oil demand is only around 100 million barrels per day.
However, the economic fallout from the coronavirus pandemic could crash demand by up to 20 percent.
This would create a 20 million barrel-per-day surplus of oil in the market that would rapidly exceed storage capacity, forcing oil producers to pay customers to buy the commodity – hence, in effect, negative oil prices.
The American government plans to purchase a total of 77 million barrels of oil starting within weeks the article states, but according to Sankey, this can only be done at a rate of 2 million barrels per day, leaving a massive excess that will be looking for a home.
Brent oil prices have already fallen to the lowest level for 17 years. The consequences for the U.S. oil industry if a coronavirus-induced recession drives down demand could be catastrophic.
West Texas Intermediate crude (WTI) collapsed by a staggering 19.2 percent to $22 while the Mexican Basket is down 22.4 percent.
For a short while, hedges will protect producers and they will continue to pump oil. While that will protect producers for a while, it encourages counter-cyclical practices; producers should be cutting back but instead will probably continue to pump and ship into store.
Francisco Blanch, a commodity strategist at Bank of America, warns in a Fox Business report that the demand destruction caused by the COVID-19 virus and the price war between Saudi Arabia and Russia could cause inventories to swell by 900 million barrels in the second quarter alone. He estimates the world currently has about 1.5 billion barrels of available storage.
Storage, however, is regional and may not match neatly with excess supply.
China continues to build storage capacity, having traditionally been short of space, but is now in a better position to take advantage of ultra-low prices.
“In a severe scenario, if the market struggles to find a home for surplus barrels, then oil prices might have to trade down into the teens,” Blanch suggests. That would leave U.S. and Canadian producers deeply in the red when hedges run out. Weaker OPEC countries, like Iraq, Iran, Venezuela, and Nigeria, could see their economies collapse, while all offshore production would be loss-making if oil prices remain suppressed into the teens over the long term.
Having laid out the worst-case scenarios, it should be said even Saudi Arabia and Russia will burn through their reserves at a clip if prices fall into the teens. As such, some form of truce, one that would support prices and reduce output, is possible.
In addition, our focus has naturally been on the direst of outcomes from the current pandemic: a combination of short, sharp lockdown shock and the acceleration of new vaccines could see us in a much more optimistic situation two months from now.
A recession? Yes, inevitably, but for how long? The first half of the year, maybe, before some form of stability reasserts itself.
Still, who can blame them? “Negative oil” has a ring to it.
Just don’t expect to get a credit to your card when you fill up your tank — it ain’t going to happen.
By Stuart Burns via AG Metal Miner
More Top Reads From Oilprice.com:
After having crashed nearly 70 percent in the first three months of 2020, benchmark WTI prices are trying to form a bottom around $20 per barrel.
But this psychological threshold is looking increasingly shaky as global crude storage facilities are filling up at an unprecedented pace. OPEC and its partners officially ended their output cut deal today, following the words of Russian Energy Minister Novak that every producer is ‘’free to pump at will’’.
With a flood of physical crude set to hit the market, it will take weeks, not months, for global oil storage space to run out. The storage problem could grow even worse as refining capacity is coming offline due to coronavirus health risks and in some cases a (very) negative crack spread caused by a double whammy of low fuel demand and crude oversupply.
Oilprice.com’s Alex Kimani wrote on Saturday that refining crack spreads are now negative in both US and Asian markets. This means that refiners must pay for every barrel they refine into fuel, which will inevitably lead to even lower demand for crude feedstock.
March has been a horrible month for oil producers, but April could get even worse.
The gap between supply and demand in oil markets is expected to grow increasingly pronounced this month. Trading giant Trafigura’s chief economist now expects demand for crude to fall by 30 million bpd in April as around 3 billion people remain under lockdown worldwide.
In the meantime, OPEC producers Saudi Arabia and the UAE are preparing to flood European and Asian markets with crude. Bloomberg reported that the Kingdom’s supply has now officially surpassed the 12 million bpd mark, compared to 9.7 million bpd. While some analysts remain doubtful that the kingdom is able to produce anywhere close to 12 million bpd, Riyadh is already resorting to drawing crude from its inventories to boost exports, and Saudi authorities have instructed Aramco to ramp up supply to 13 million bpd.
Saudi Arabia’s ally the UAE has also vowed to increase production. State-owned ADNOC said on March 11 that it was looking to increase production to 4 million bpd, one million barrels per day higher than it produced under the OPEC+ output deal.
To make matters worse, Iraq said on Tuesday that it would raise production by 200,000 bpd to 4.8 million bpd according to Bloomberg.
It seems then that Riyadh is defying pressure from Washington and Moscow to halt its production surge. Thus far, the Trump Administration hasn’t taken any serious action to force the Saudis to stop the oil price war, but according to Reuters, ‘’U.S. President Donald Trump said on Tuesday he would join Saudi Arabia and Russia, if need be, for talks about the fall in oil prices’’
The question then is whether the Saudis will be successful in their high-risk gamble for market share. Before starting the oil war, Riyadh surely anticipated that the extra barrels it would free up for exports would sell at a steep discount to Russian and US crude grades, but what it didn’t expect is that there may not be any demand for its additional crude as refiners simply can’t handle any more feedstock (and probably won’t be able to store it either).
Bloomberg’s Ellen Wald says that the current Saudi strategy could come at a huge cost for the kingdom, ‘’Leftover, unsold oil sitting in tankers off the coast of Saudi Arabia will make the kingdom look weak. Aramco and the kingdom would face severe revenue drops…undermining the overall economy and the monarchy’s political dominance’’.
Whether or not the Saudis manage to capture market share, U.S. producers are set to lose the most. Oil prices in many states have fallen into the teens and in some states we are already seeing oil selling for $1 per barrel, causing producers to shut-in a huge number of wells as demand for their crude is slowly drying up.
By Tom Kool of Oilprice.com
More Top Reads From Oilprice.com: