Crude oil’s punishing collapse
On Monday, the price of crude oil set a fairly ominous record. For the first time in American history, the price of a barrel of crude oil fell below zero.
After opening at $18.27/barrel, the price quickly plummeted and closed at -$37.63. No, that’s not a typo. On Tuesday, crude oil bounced back into positive territory, closing at $10.01/barrel. By Thursday, its price had reached $16.50.
Crude oil is a global commodity, subject to global forces of supply and demand. The benchmark grade of crude oil produced in the U.S. is West Texas Intermediate (WTI), which serves as one of three main pricing barometers of the global petroleum industry, alongside North Sea Brent and Dubai crude.
For much of the past three years, the price of WTI has hovered between $50-$60/barrel. Then, in early March, the price suddenly fell to $20. The trigger was the collapse of a three-year agreement between Russia and OPEC (Organization of the Petroleum Exporting Countries) to limit production to help bolster crude oil prices. OPEC is a 14-nation oil cartel, led by its de facto leader Saudi Arabia, that controls roughly one-third of the world’s crude oil production.
Russia balked at OPEC’s demands for even deeper production cuts. In a punishing tit-for-tat, both Russia and OPEC suddenly increased their crude oil production. This epic tantrum of crude oil heavyweights added millions of barrels of crude oil each day to an already over-saturated global surplus. As expected, crude oil prices plunged.
The COVID-19 virus has further compounded this crisis, as demand for crude oil has severely declined. According to the International Energy Agency, global demand for crude oil this year is expected to reach a 25-year low. Demand for crude oil – as well as its many distillate products such as gasoline, jet fuel, kerosene, heating oil and lubricants, among others – has fallen as consumers stay quarantined and businesses and manufacturers remain in lock-down. Some estimates project that 40% of the world’s population is currently under stay-at-home advisement.
With oversupply and reduced demand, storage capacity for excess crude oil is being maxed out. Many producers have no place to put their oil. For those oil companies that have some capacity left, they’re not buying more crude oil. For those with no capacity left, they’re forced to sell their excess crude for almost nothing.
As Monday’s closing price of -$37.63 appears to indicate, sellers were actually paying buyers for each barrel of crude oil they sold. The sellers’ payments were necessary to cover the buyers’ costs tied to purchasing a barrel of crude oil, such as transportation and storage.
The role of the U.S. crude oil producing industry is significant. In late 2018, the U.S. surpassed both Russia and Saudi Arabia to become the world’s largest producer of crude oil. Today, the U.S. accounts for 19% of the world’s total production. In March, U.S. crude oil production reached 13.1 million barrels per day, a record high.
The U.S. crude oil producing industry is already reshaping. For American producers, the typical break-even price for a barrel of crude oil is $46-$52. For some oil wells, the break-even point is around $30-$40. But the lower the price of crude oil falls, the more oil wells become unprofitable and are forced to shut down. Since March 1, the number of active oil rigs has dropped by 35%, falling from 678 to 438.
The collapse of crude oil prices does provide lower gasoline and energy prices for American consumers and businesses. The U.S. is the largest consumer of crude oil, accounting for 20% of all global consumption. Moreover, 36% of all U.S. energy is derived from crude oil – America’s No. 1 source.
But these low prices carry a cost – a devastating impact to the U.S. energy sector. The U.S. energy sector drives roughly 8% of U.S. economic growth and 6% of all jobs. It also infuses hundreds of billions of dollars in annual capital investments to America’s infrastructure – drilling, refineries, storage and transportation. As the U.S. energy sector becomes impaired, so does manufacturing, construction, shipping and trucking and many other key components of our economy.
America’s crude oil producing industry will rebound. However, as with much of COVID-19’s impact on the U.S. economy, when that recovery will happen is the great unknown.
Mark M. Grywacheski, Investment Advisor
Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets, or developments mentioned.
Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
