The oil demand has collapsed in an unprecedented way, crashing to 18-year lows. In empty highways, grounded planes, and the dark factories worldwide, the thirst for oil has evaporated.
However, supply remains largely resilient amid a price war between Saudi Arabia and Russia. US producers also don’t want to turn off production, which means the world will soon run out of space to store unneeded oil barrels.
“The market is starting to signal that not only is there no demand for this crude, eventually there could be nowhere for it to go,” said Jeff Wyll, a senior energy analyst at Neuberger Berman.
This situation hasn’t happened since 1998, that refineries, storage facilities, ships and pipelines, terminals, eventually could reach capacity according to Goldman Sachs.
Regarding oil pricing, investors have already taken up the risk that might occur soon as per the distressed pricing in some oil market corners. West Texas Intermediate and Brent are trading north of $20 a barrel, and recent prices in some regions have plunged into single-digit territory. The storage is even trickier for landlocked grades of crude.
“Demand is falling so fast relative to supply that very soon many producers’ main issue is not going to be whether they can ensure operating profit but rather if they can find an outlet for their crude,” analysts at JBC Energy wrote in a report Tuesday.
Loading extra crude onto ships could be one option. JBC said about 20% of the global fleet of large crude carriers (VLCCs) could be made floating storage. But that even would not absorb the surplus.
In April, around 6 million barrels per day might have nowhere to go, JBC said, and that figure would rise to 7 million barrels daily in May.
Below zero oil prices
The recent oil glut has caused a drop in some obscure grades of oil below zero. As Bloomberg News reported last week, a Wyoming crude grade was recently bid at negative 19 cents a barrel. The shrinking storage capacity means oil producers, in some cases, might have to pay someone to take the barrels off their hands.
“The price is trying to go to a level to force companies to keep the oil in the ground. If it has to go negative to incentivize that behavior, then it will,” said Neuberger’s Wyll.
Brent, the global benchmark, is priced on an island in the North Sea where tank storage is accessible and therefore is protected, but other grades of crude are located far from water. As WTI is 500 miles from water, Goldman’s Currie said WTI, especially WTI Midland, and Canada’s Western Canadian Select “can go negative.”
Certainly, subzero oil prices are bizarre, but the energy market also contains some limited precedence.
Last year, due to the lack of pipelines to carry the gas away, US natural gas prices in West Texas traded in negative territory for two weeks and more, Reuters reported.
“Mother of all market surpluses”
Still, negative prices of natural gas didn’t discourage production. The West Texas natural gas was mostly a by-product of oil pumped from the Permian Basin, and the oil companies were willing to take a loss on the natural gas to get what was a valuable barrel of oil then.
The abnormal drop in oil prices has caused the loss of more than two-thirds of the value oil since the January peak.
US oil companies are though reluctant but now starting to make the painful decision of “shutting in” production.
According to Goldman Sachs, physical constraints have forced a minimum of 900,000 barrels per day of announced “shut-ins,” and the actual number is likely higher and “growing by the hour.”
In April and May, the “mother of all oil market surpluses” will force large production shut-ins, Rystad Energy said. However, the older and less productive oil wells will likely be shut down first.
The most influential US oil companies also decided to scale back spending and production. Chevron (CVX) has announced plans last week to slash spending by 30% and lowered its output targets in the Permian by 20%.
Goldman Sachs said, eventually, the industry could lose at the most 5 million barrels per day of oil supply capacity.
Will the oil shock stage appear?
It’s for sure that the weak demand caused by the coronavirus pandemic won’t last forever. Airlines will start buying jet fuel to go air, and American drivers will get back to work with more gasoline.
However, the oil industry might not be producing as much oil as before by that time because of shut down of wells. Today’s oil glut may turn into tomorrow’s oil scarcity all of a sudden with price hike “far above” $55 next year, Goldman Sachs commodities head Jeffrey Currie said.
“This will ultimately create an inflationary oil supply shock of historic proportions,” Currie wrote.