The pain in the oil patch continues. The only thing that’s going to fix this is re-opening the world economy
Yesterday brought grim news from the oil sector …
The May contract for U.S. West Texas Intermediate (WTI) crude … erased all value and dropped below zero for the first time in history.
Now, while this was factually true, the reality wasn’t quite as scary as the headlines made it out to be.
For any readers who don’t follow commodities, traders use what are called futures contracts when they’re trading. These contracts reflect what traders believe will be the price of a particular commodity, out in the future, hence the name.
If you’re holding a futures contract on the day it expires, you effectively “take ownership” of whatever commodity is related to that contract. Today is the expiration date for May WTI futures contracts.
Given this, yesterday, traders who had no interest in having a huge truck of oil show up at their door, had to sell their contracts to escape taking ownership.
In the scramble to avoid this outcome, technically, the price of a barrel of WTI ended Monday at negative $37.63.
Now, obviously, the value of oil itself in no way approached zero. Yesterday’s crazy pricing reflects a different reality — namely, the world is running out of places to store the glut of oil on its hands.
***While yesterday’s news sounded grim, the more concerning dynamic is playing out today with the WTI June futures contracts
Yesterday, the June WTI contract, which expires on May 19, fell about 18% to land at $20.43 per barrel. As I write Tuesday morning, the selling pressure hasn’t let up. The June WTI futures contract is down another 28% to $14.58.
This is an existentially low market price for the overwhelming majority of U.S. oil companies. More on that in a moment …
Now, if we look further out toward the end of the year, traders are pricing the December WTI contracts in the $30s.
We need this to happen — and hopefully far earlier than December.
***How will the world get back to normal with oil?
To make sure we’re all on the same page, in early March, a disagreement between Saudi Arabia and Russia about oil production led the Saudis to flood the market with crude. Meanwhile, a world on lockdown due to the Coronavirus effectively kneecapped demand.
The combination of oversupply and under-demand resulted in the price of oil plummeting. It’s fallen by roughly 75% in 2020.
Given this, two weeks ago, Saudi Arabia and Russia moved beyond their spat, and along with other oil-producing countries, agreed to slash production by 9.7 billion barrels per day in May and June. This is the largest cutback in history.
News from this morning is that the Saudis are considering implementing those cuts immediately rather than waiting to May to help offset the pricing pressure in the market.
Unfortunately, regardless of whenever these cuts begin, they won’t fix low prices in the near-term. That’s because the cuts impact only the “supply” side of the equation, there’s still “demand” to contend with … which has been hobbled by COVID-19.
Here in the U.S., we’ve seen oil demand fall off a cliff. According to the U.S. Energy Information Administration, 69% of oil U.S. oil consumption goes to the transportation sector. That’s gas for our cars and cargo trucks, as well as fuel for air travel.
Below you can see demand for motor gasoline falling to levels not seen in 25 years.
Source: Axios
Meanwhile, the cumulative impact of travel bans, stay-at-home orders, and social distancing has resulted in the number of flights in the U.S dropping precipitously. The flight-tracking website Flightradar24 recently showed a dramatic reduction in the number of aircraft over southern Canada, the U.S. and Mexico — about a 36% drop.
As to when this might change, experts say it will take months before global travel restrictions are completely lifted, and years before worldwide demand for air travel will climb back to pre-crisis level.
Given this reduction in demand (looking global now, not just the U.S.), reports estimate that oil demand has fallen by somewhere between 25 million barrels and 35 million barrels a day.
So, Saudi Arabia and Russia will cut production by 9.7 billion barrels per day? Great, but that’s only a third of what’s needed to offset the dry-up in demand.
Bottom line, supply cuts won’t fix low oil prices anytime soon. The only thing that’s going to drive them back up into the $30s and higher is a resurgence in demand brought about by the reopening of the world economy.
So, where are we with that?
***The status of the global “reopening”
First, in positive news, the U.S. is eyeing a partial reopening of the economy, with Georgia and South Carolina reopening parts of their economies this week.
Plus, around the world, Denmark, Germany, Czech Republic, and Norway have all just lifted some restrictions.
While we’re optimistic, the obvious danger is that too much re-opening too soon could send these countries back into lockdown mode, extending the economic pain.
For example, certain Asian countries experienced the pandemic earlier, controlled the outbreak, and loosened restrictions. These countries are now seeing a resurgence of cases.
From Vox:
Hong Kong isn’t the only place in Asia that did a good job controlling its initial coronavirus outbreak only to see a resurgence of coronavirus cases.
Singapore and Taiwan were both seen as examples of how to handle the coronavirus outbreak: stanching the growth of infections, while largely keeping their economies open …
This has changed, to varying degrees, as the threat of new cases rises both within these places’ borders, and without …
Because as long as the coronavirus is spreading somewhere, it can spread everywhere. That is why no country has beaten the coronavirus yet.
In China, as authorities were relaxing Wuhan’s 77-day quarantine, residents in Suifenhe (near the Russian border) were being locked down for the second time in three months. What’s interesting is that Suifenhe had no official cases reported while most of the other Chinese cities affected by COVID-19 were under lockdown.
We see a similar dynamic in Singapore. While the country was applauded for its response to Coronavirus, keeping its cases low, the situation has grown worse recently.
Since March 17, Singapore’s confirmed coronavirus cases grew from 266 to more than 5,900 as of last week. And as of yesterday, that number had surged beyond 9,000 cases. The country is now on lockdown.
We’ll be watching Georgia and South Carolina with cautious optimism, but until there’s either a cure or a vaccine, the world will be running at half-speed. And that threatens to keep demand for oil — and oil prices — dangerously low.
***This lack of demand is already inflicting massive damage on U.S. shale oil producers
With WTI prices in the mid-teens, it’s a threat to countless oil production companies.
Here in the U.S., many shale oil production companies simply will not be able to survive if oil remains at such depressed levels. For context, according to a Dallas Federal Energy survey, the average breakeven oil price in the U.S. is in the $48 to $54 per barrel range.
As we noted in the Digest several weeks back, Whiting Petroleum, once a rising star in the shale industry, has already declared bankruptcy. And CNN reports that nearly 100 U.S. oil and gas producers could file for bankruptcy over the next year.
The Dallas Federal Reserve survey indicates that at $40 a barrel, only 15% of companies could survive for a year or less.
Of course, we’re not at $40 a barrel. As noted earlier, the June WTI contract trades at $14.58 per barrel. This is unsustainable for the U.S. energy complex. Even $20 oil would be.
What would happen if WTI hovers around $20 for the foreseeable future?
Well, according to Rystad Energy, 533 US oil exploration and production companies will file for bankruptcy by the end of next year.
***The hope is that we’re making progress on the medical front
As noted in a Digest last week, drug-maker Gilead leaked impressive results from a clinical trial it is conducting on its antiviral drug, Remdesivir. If it does, in fact, cure COVID-19, then the world-economy could potentially re-open in weeks or months … helping drive demand and raise oil prices.
We’ll cross fingers that happens and continue to keep you updated here in the Digest.
In the meantime, we continue to urge oil investors to thoroughly research the oil stocks they own.
From our March 30 Digest:
If you own oil production companies, it’s critical that you research your company’s break-even production cost. Find out how it’s addressing this crunch — is it shutting down rigs? Postponing expansion into new shale fields? Cutting a dividend? Has it effectively hedged the price of oil at higher levels? If so, for how long?
Beyond this, dig into your company’s financial statements to find out when its debt matures. The longer you have, the better. And what’s the cash position on the company’s balance sheet?
Armed with this information, you may decide to ride out the storm, or you may choose to sell. That will be a reflection of what your research turns up, as well as your unique investment situation.
Either way, as you research, remember — the name of the game is cash preservation. The companies with it will survive. Those without it may be forced to shut their doors.
Bottom line — if oil prices remain in the low $20s for a sustained period, many players in the U.S. shale industry are facing an existential crisis. As the CEO of Pioneer Natural Resources recently said, “probably 50% of the public E&Ps (exploration and production companies) will go bankrupt over the next two years.”
Have a good evening,
Jeff Remsburg
