The global oil industry is facing a crisis that was unimaginable just a few weeks ago. As a child growing up in the OPEC cartel years in the 1970s, I never thought I’d see the day when you could get crude oil—as much as you want—for free. That happened for the first time on April 20, throwing the industry into a tailspin. Is this just further fallout from a global pandemic, or is there a bigger story to tell? More importantly, what is the end game?
The industry wasn’t the first one clobbered by COVID-19, but it was certainly the most public, and it didn’t lack for drama. Concerned for quite some time about oversupply, the industry was hit with a virus-related collapse in demand. Failure of the OPEC+ community to agree on appropriate output cuts sent West Texas Intermediate crude from the US$50 level to US$30 per barrel on March 9. That was bad enough; talks to remedy the situation were on-again, off-again, causing prices to dip as low as US$20. Things were looking bleaker to close out last week, but the impasse on supply restrictions was too much for the market to bear. With storage capacity almost fully used up, producers in Western Canada were paying “buyers” to take oil off their hands: prices went negative.
It’s rare, but every now and then this can happen to a market. When it’s hard to stop production in the face of low sales, the cost of storing excess output can become so great that it’s worth it to the producer to pay users to take it off their hands—if the cost is less than what they’d be charged to store it. It’s a desperate situation that cannot last long, regardless of the industry that’s encountering it. How did it come to this, and of all possible industries, in oil?
Well, it didn’t just happen overnight. After all, in the years leading up to 2008, serious geological studies concluded that we were running out of all the inexpensive sources of oil. Prices zoomed up, as did exploration, development—and innovation—in non-conventional oil. This unleashed vast new supplies from shale formations, bringing prices back down from their dizzying heights. Instead of killing off the new, higher-cost sources, it caused them to develop creative cost-reducing techniques that increased production. This precarious global supply-demand situation was then faced with the Chinese lockdown, which bit deeply into global demand. But when the developed world followed suit, the daily commute dried up the single largest source of global demand, not to mention the vastly lower draw from big industrial users. Without a significant supply-reduction scheme, prices were definitely in trouble.
Post-COVID-19 resumption of demand won’t be a full cure. It will lift prices from the current zero-level, but production is simply too dispersed among OPEC and non-OPEC players that nothing short of a radical and widespread supply-restriction scheme will bring prices back to the US$50+ level. As such, EDC Economics is forecasting that prices will remain below US$40 per barrel on average next year, and will stay shy of the US$50 level through 2023. And risk seems squarely on the downside.
Canadian producers have been pummelled by conditions, and as feared, prices went negative on April 20. Producers can make money at current forecast levels, but it’ll be hard for many to survive a protracted period of near-zero pricing. Bearing sectoral duress in mind, the federal government announced an assistance package for the sector on April 17 aimed at helping it survive the worst of this COVID-19 period. Unlike most other industries, it seems that oversupply in oil is going to be with us for some time. Barring international agreements on supply restrictions, which are far harder to achieve and enforce than in the past, the industry seems likely to struggle for some time to come. Having said that, it’s also one that is highly sensitive geopolitically, so taking a hard and fast line on a particular view of prices is a dangerous game. At the same time, the price mechanism itself has repeatedly shown that it’s one of the key enemies of a trend forecast: low prices encourage higher consumption that eventually undo the low prices. The wild card this time is environmental consciousness.
The bottom line?
COVID-19 has devastated an already-stretched global oil market. These are its bleakest moments, typically producing radical, apocalyptic pronouncements. Those invariably prove wrong, but fundamentals strongly suggest that there are no easy roads back for this sector. One thing is clear: This is a sector that has shown extraordinary creativity during moments like this. All we can hope for is that this episode is short-lived—and that it gives rise to the next set of amazing energy-sector innovations.
