NRPLUS MEMBER ARTICLE F or the first time ever, the price of U.S. crude oil has gone negative as the coronavirus pandemic obliterates demand for energy. On Monday, traders and producers paid as much as $40 for the privilege of parting with a barrel of oil.
West Texas Intermediate (WTI) crude sold for more than $60 a barrel just a few months ago. Following the outbreak of the coronavirus, a global collapse in economic activity, coupled with a price war between Saudi Arabia and Russia, brought the price of crude to its lowest level since the 1997 Asian financial crisis. Plummeting prices have set off a mad dash to store oil, as producers hope to weather the storm and sell their supply after the pandemic. But storage space is finite and growing ever more expensive as buyers disappear from energy markets. Monday marked the first time that one month’s storage costs exceeded the spot price of oil. Rather than cover those costs, traders paid to get rid of their oil.
The speed of the sell-off reflects the deadline of the May futures contract. Traders and exchange-traded funds in commodity markets exit positions by selling futures as they expire. Otherwise, they would receive physical shipments of oil — which they don’t want. (It’s hard to store barrels of crude in a Tribeca loft.) Monday was the last day to exit May futures before their Tuesday expiration date. As traders rushed to offload their contracts, prices collapsed — with a gap of $60 between May and June WTI futures. Commodity analysts call it “contango” when oil for delivery in the future costs more than oil for immediate delivery.
The pandemic has hit U.S. oil producers harder than their peers because the domestic oil supply is landlocked. Unlike Brent crude — a waterborne oil delivered by producers to the North Sea — WTI is traded through Cushing, Okla. Because of the higher logistical barriers of transporting oil across land, West Texas oil trades at a discount to Brent, which fell by 9 percent to $25 a barrel Monday.
The move in oil accentuates the near impossibility of stimulating the economy during a global shutdown. Just over a week ago, the U.S. and OPEC+ — an expanded oil cartel that includes Saudi Arabia and Russia — agreed to cut production by nearly 10 million barrels a day. Despite unprecedented international coordination, with the U.S. government intervening in energy markets for the first time, supply cuts have failed to prop up prices. No amount of output restrictions can force planes into the air or workers into the factory. And the pandemic comes at a time of massive global output driven by the U.S. fracking boom.
Collapsing oil prices will hurt high-cost producers the most, including those in the U.S. and emerging economies such as Venezuela, Nigeria, and Angola. Shale producers lose money when the price of crude sinks below $50. Facing a protracted demand slump, high-cost producers will “shut in” supply, closing oil wells until prices stabilize. For highly leveraged U.S. shale companies, near-zero revenues will likely lead to bankruptcy. For petrostates such as Venezuela, negative oil prices could pose an existential threat.
But when economic activity picks up, shuttered production is expected to cause a large increase in the price of oil: Demand will pick up just as wells shut down. In the long run, the U.S. may stand to benefit from depressed prices. For one, consumers will face lower prices at the pump, and businesses will pay less for energy. But beyond that, shale has an inherent advantage in that wells can be shut down and restarted relatively easily.
Once markets normalize, oil and gas fields that have shut down will take years to bring back online, and shale producers will be well positioned to fill that demand. In the meantime, though, we’ll likely see consolidation in the oil industry as oil majors with healthy balance sheets buy up distressed shale assets.