Why the oil price has gone negative: Crude market facing a perfect storm as plunging demand leaves over-supplying producers paying to get rid of the black stuff
Unprecedented is a word in wide – but often inaccurate – usage at the moment, but it is appropriate when it comes to the current conditions in the oil market.
This week has seen WTI Crude, the main American oil benchmark, briefly going to a price of negative $37 at one point. In other words, producers have to pay people to take it off their hands.
Essentially, what has caused this week’s plunge is the demand side becoming as much of a problem as the supply side of the oil market.
The recent and ongoing slump was initially triggered by the supply side in the form of a breakdown in the fragile peace between Saudi Arabia-led cartel OPEC and Russia.
The Yarakta Oil Field owned by Irkutsk Oil Company in Russia, one of the countries at the centre of the storm
OPEC and Russia typically work together to manipulate the supply of oil to the world market to ensure the price of a barrel is roughly where they want it.
This largely takes the form of cutting supply when demand falls and letting it creep up when demand is strong.
This came to an abrupt end last month though as the two main players had a sharp disagreement on how much each party should reduce output, and the result was both refused to cut back, creating a glut.
The oil price had already been under continuous pressure for years due to the rapid increase in shale oil production in North America, which makes use of hydraulic rock fracturing methods that did not exist before.
Demand has now dropped off just at the wrong time, due to the ‘black swan’ event dominating all our lives at the moment, the SARS-CoV-2 outbreak. Planes are grounded and people aren’t driving much. This has created a perfect storm.
It should be noted though that the other major yardstick for oil, the Brent Crude price, remains positive albeit at a paltry $20 per barrel. Better, but still a 21-year low.
This difference largely stems from the fact that there has been a severe shortage of viable storage for WTI Crude, meaning it has to be offloaded to the market with greater urgency.
Storing oil incurs a cost, and if the price is too low these costs are no longer worth incurring. Facilities may refuse to take it even if they have space, further exacerbating the situation.
Brent Crude is more often stored at sea in oil tankers, which have not yet been put under pressure to the same extent as the land-based storage used for WTI.
The only hope of easing this situation in the near term is for Saudi Arabia, Russia and other major producers to drastically cut production. Whether the discord can be bridged is questionable.
An oil pump jack in a Texas oil field, where available storage facilities are running low
The demand side will not come to the rescue any time soon as it will require the ending of the virus crisis and a strong recovery in the global economy.
There are many implications of the situation beyond the price of a barrel. While the big players can ride this out for a long time, it will decimate their profits and potential to pay out dividends to their shareholders. This hits investors big and small straight in the pocket.
Smaller firms in the industry or connected to it face an even worse situation, and many could well go under.
The knock-on from oil firms of all sizes struggling is that they cut staff and capital spending, which impacts the economy bother locally and globally.
There is an upside in the form of cheaper fuel for businesses and individuals, but the benefits of this take time to come though into the real economy. We all notice this reality when we go to get petrol and find the price still stubbornly over £1 a litre in most places.
Such benefits only have a chance of counterbalancing the costs on macro level for countries which are not big exporters of oil, of course.
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