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Oil Prices in Free Fall: How We Went From Peak Oil to Negative Oil

| By: Randall E. White, CFP®, RICP®, CRPC®, CMFC®

Oil Prices in Free Fall: How We Went From Peak Oil to Negative Oil
Wednesday, 20 May 2020

Just when we thought we had finally seen it all, the COVID-19 pandemic forced oil prices into the negative for the first time in history. Producers were paying as much as $37.63 per barrel as of April 20 to get buyers to take oil off their hands. While one might think finding buyers willing to be paid to accept free oil might be easy, the sharp drop in demand in recent months has lead to a massive oversupply of oil such that buyers have nowhere to physically store it. Some producers have reportedly paid nearly $100,000 per day to lease oil tankers that enable them to store their oversupply at sea.

How We Got Here

How did we go from peak oil prices of $150 per barrel 15 years ago to negative pricing recently? In short, coronavirus has acted like a lead foot on the brakes of a car and air travel worldwide, with safety restrictions severely limiting flights, requiring workers to stay home and non-essential businesses to temporarily close. At the same time, both China and India – two of the world’s largest importers of crude – shut their borders in attempts to contain the coronavirus outbreak.

Demand fell so sharply, in fact, that it has been impossible for oil-producing countries and companies to reduce their outputs at the same rate of speed. Thus, they were forced to pay buyers to take excess oil off their hands for the first time in global history.

By the Numbers

If you had seen the data a year ago – or even a couple of months ago – you may not have believed it to be possible. Not only did oil prices climb to $150 a barrel in recent history, but it’s unheard of for companies to pay good money to unload their products, especially in an economy heavily reliant on oil.

It’s clear there has been a massive collapse as the COVID-19 pandemic has unfolded. Globally, demand fell an unprecedented 29 million barrels per day and, even with some reduced production, storage capacity filled up quickly, necessitating the brief period in April when prices fell into negative territory at -$37.61.

Market Impact

Oversupply concerns roiled the markets, and two important benchmarks led crude to a tipping point. Brent, the international oil benchmark, fell almost 70 percent from January to April. In North America, the West Texas Intermediate (WTI) fell to its record low of -$37.61 – its first-ever negative dip. This caused the popular United States Oil Fund to dump its June WTI contracts and reduce its subsequent contracts. The sell-off startled investors, and volatility in the oil market spilled over into other sectors, as well, though the impact is expected to be temporary.

Oil remains a valuable commodity, in reality, meaning it does not truly have a negative worth, even at this strange time in world history. The negative pricing specifically concerned crude oil delivery contracts for the month of May that are traded on the futures market. Now, month-out contracts are back in positive territory, at approximately $30 per barrel. This is good news, as it suggests that oil traders expect supply to match demand again soon.

Where We Stand Now

At this juncture, crude exporters have shut down 13 percent of the U.S. drilling fleet. Similarly, the OPEC companies and Russia have announced they will reduce their collective outputs by 9.7 million barrels per day. Since we are in uncharted territory, it remains to be seen whether private oil drilling companies will be forced into bankruptcy.

The federal government is leasing space to increase the Strategic Petroleum Reserve, reportedly by 47 million barrels. The White House has also proposed incentivizing U.S. fracking companies to keep their oil in the ground. However, shut-down oil facilities can be permanently damaged quite easily, and it is also very costly to restart drilling operations.

As states begin to loosen lockdown restrictions and reopen for many businesses, it remains to be seen to what extent demand may increase. One thing is certain, however: we are witness to an unprecedented time in history, and negative oil was a startling economic reminder of that fact.


Sources:

https://www.npr.org/sections/coronavirus-live-updates/2020/04/20/838521862/free-falling-oil-prices- keep-diving-as-demand-disappears

https://www.cnn.com/2020/04/28/investing/oil-prices/index.html https://www.weforum.org/

https://www.bloomberg.com/news/articles/2020-04-19/oil-drops-to-18-year-low-on-global-demand- crunch-storage-woes

https://www.economist.com/graphic-detail/2020/04/19/american-crude-oil-has-fallen-to-less-than- nothing

https://www.politico.com/news/2020/04/20/oil-companies-trump-administration-paralyzed-196473

https://www.marketwatch.com/story/about-150-years-of-oil-price-history-in-one-chart-illustrates- crudes-spectacular-plunge-below-0-a-barrel-2020-04-22

https://www.cbsnews.com/news/negative-oil-prices-what-does-that-mean/


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