As the coronavirus continues to force Americans inside, the demand for oil has plummeted. Airplanes are virtually empty, cars remain in their driveways, and factories are operating at a fraction of their capacity.
America’s normally insatiable demand for oil has temporarily disappeared, creating unprecedented panic in the American oil industry.
Plenty of Supply, But No Demand
For more than six weeks, Americans have remained close to home. Empty hotels, cruise ships, airplanes, beaches, schools, and theme parks serve as a stark reminder of the dramatic lifestyle changes social distancing guidelines and lockdown orders have required.
As a result, the demand for oil has plummeted. As BP CEO Bernard Looney said in a statement, “Our industry has been hit by supply and demand socks on a scale never seen before.” BP experienced a 66% plunge in its first quarter profits, and the major oil company isn’t alone.
For the first time since 2017, major oil benchmarks are on pace for four straight months of losses. This has translated into lower prices at the pumps for many Americans, but the correlation between oil prices and gas pump prices isn’t quite so simple.
Why Did Oil Futures Crash?
On April 20, oil futures fell into the negative and traded well below $0 a barrel for the first time in history. This negative price shock was the result of a perfect storm of events. First, traders and investors panicked when they learned that the nation’s 91 million barrels worth of storage capacity for crude oil was almost entirely used. They desperately dumped futures contracts, creating a massive domino effect.
“If you enter into a futures contract, then there’s an obligation for the product to change hands at a specific point in time,” explains Charles F. Mason, University of Wyoming professor of petroleum and natural gas economics. “What we’ve seen here is that the people who held the futures contracts and therefore were obligated to take possession of the crude at a certain point in time had no place to put it because storage capabilities were filling up.”
The resulting negative oil prices, which fell as low as -$37.63 a barrel, meant someone with a long position in oil would be forced to pay someone else to take the oil off their hands. These traders were terrified that they wouldn’t be able to find a place to physically hold the oil.
At the same time, Saudi Arabia and Russia flooded an already oversupplied market with excess crude oil in the course of their epic price war. President Trump ultimately intervened and confirmed that OPEC+ agreed to cut oil production by a record 10 million barrels. That production cut begins in May, and experts hope it will reflect positively in the prices of oil futures.
According to S&P Global Platts’ global head of analysis Chris Midgley, “Despite forthcoming OPEC+ production cuts, more production needs to be cut- particularly in the US and Canada to avoid tank tops by June.”
Looking Forward to the Post-COVID Economy
The behavioral changes precipitated by COVID-19 have undoubtedly caused the dramatic plunge of oil prices. But what happens when the immediate threat of coronavirus passes and Americans can get back to work?
There’s no general consensus, but Goldman Sachs analysts are encouraging investors to commit to energy stocks in anticipation of lasting recovery in the oil industry. As America inches closer to reopening and recovering from the coronavirus pandemic, demand for oil will increase. Though it may take a few months, supply will no longer overwhelm storage capacities and oil futures will start to normalize.
From there, there’s a strong “potential appreciation for oil… once the current temporary issues are resolved,” writes Matt Weller, global head of market research at GAIN Capital.
Sources
- https://www.marketwatch.com/story/why-the-oil-market-just-crashed-below-0-a-barrel-4-things-investors-need-to-know-2020-04-20
- https://markets.businessinsider.com/commodities/news/oil-price-buy-energy-stocks-why-goldman-lists-reasons-plunge-2020-4-1029139451#
- https://www.marketwatch.com/story/oil-prices-bounce-higher-ahead-of-us-inventory-data-2020-04-29