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Oil prices have collapsed by more than half this year, to $23 per barrel today for West Texas Intermediate crude. But now is not yet the time to buy oil—because the worst is yet to come. Gasoline demand is set to plunge 50%, while jet fuel consumption has all but evaporated, with 87% fewer flyers taking to the air than a year ago.
Every doomsday forecast is more dire than the last. Amrita Sen at Energy Aspects this week forecast a 10 million barrel per day drop in petroleum demand this April. Jim Burkhard at IHS Markit sees a gap between oil supply and demand widening to 12 million bpd in the second quarter. Analyst Damien Courvalin and his team at Goldman Sachs now see a worldwide drop in demand of nearly 19 million barrels per day. Worsening the glut, Saudi Arabia and Russia are only beginning to ramp up their oil output in a fight over market share.
Oil companies have begun to respond to the crash, already slashing more than $40 billion off 2020 capital spending budgets, half by U.S. shale frackers. Occidental Petroleum on Wednesday announced a second cut to its 2020 cap-ex this month, now down by half to $2.7 billion. Oxy will cut its drilling rigs in the Permian Basin from 20 to 4.
But it’s not enough to just reduce investments. Big Oil is going to need to shut in oil wells altogether—because soon they will run out of sufficient storage tanks and floating tankers in which to put the stuff. “Production is going to have to be reduced or even shut in. It is now a matter of where and by how much,” wrote Burkhard of IHS this week.
The deterioration of conditions in the Lower 48 is only just getting started, with 100,000 bpd of production cuts so far, according to Tudor, Pickering & Holt. On Wednesday the Dallas branch of the Federal Reserve released its survey of conditions in the oil and gas sector, and included anonymous quotes from industry execs. “We are now expecting an almost total stop in business,” wrote one. “My outlook on the domestic oil and gas industry has never been bleaker,” from another. The expectation is for a “bloodbath at most firms.”
The domino effect is beginning. People travel less. So refineries are unable to sell their fuel, which builds up in storage tanks. Wholesale gasoline is selling at less than 50 cents per gallon. Refineries are losing money on every barrel they process, with Gulf Coast gasoline crack spreads plunging to a –$17 (that’s minus 17 dollars) per barrel. Unwanted crude oil will in turn fill up the big storage hubs like Cushing, Oklahoma. During the 2016 downturn, output of U.S. shale oil fell by 1.1 million bpd. This time around the expectation is for a cut of at least 1.5 million bpd, to 11.3 million bpd at the end of 2021.
In order to adequately incentivize these shut-ins, look for oil prices to go below “cash costs,” that is, the outlay a producer has to make today to run its existing wells and pay workers to get the next barrel out of the ground. Today those thresholds are about $9 per bbl for OPEC nations and $15 for non-OPEC. According to a note from Goldman Sachs analyst Damien Courvalin (and team), “U.S. crude saturation will likely lead WTI prices to fall well below $20/bbl.”
Regions far inland, with complex logistics, will be the first to shut in. The Canadian oil sands producers have reduced their output by roughly 100,000 barrels per day; producers in western Canada have been paid just $7.50 per bbl for their crude this week. While in the Bakken shale, producers are only getting $15/bbl, according to Lynn Helms at the North Dakota Department of Mineral Resources.
Gird yourself for devastation. The U.S. oil sector is now straining under $160 billion in distressed debt. Rystad, a consultancy, expects losses of more than 200,000 energy-related jobs in the U.S. this year.
Could we get some relief if President Trump manages to convince the Saudis and Russians to call off their price war? Probably not, as the scale of their additions to the market (about 1.5 million bpd) is dwarfed by the destruction in demand caused by coronavirus lockdown. “If anything, the Kingdom is going for Russia’s jugular, with Aramco not only pushing huge volumes onto the market but specifically trying to displace Urals as a feedstock for European buyers,” writes Amrita Sen of Energy Aspects. The Saudis did the same thing in 1998, she notes, flooding the Gulf Coast refiners with heavy sour crude in order to rebuff a Venezuelan grab for market share. The move sent WTI down to $10/bbl in late 1998.
Perhaps worst of all—shutting in oil wells can cause permanent damage to reservoir rock and make it impossible to regain previous output levels later, leading to significant capital impairment. As a result, when the world returns to normal we may find there’s not enough oil ready to come back on line. According to Goldman Sachs, that could cause trouble for a world economy struggling to emerge from recession, “with a normalization in activity increasingly likely to be accompanied by a large inflationary oil shock.”
