2020 has not been a great year for oil, and that’s an understatement. A combination of falling demand, rising supply, storage shortages, and late deals have led to oil prices reaching historic lows. This article will discuss what has caused this new low, and how the near future will look for oil markets.
When the coronavirus broke out, countries started closing up. The air and roads in most countries started to empty, as most people refrain from leaving their houses. Airlines worldwide have most of their fleet standing still, and travel all but stops existing. The impact is immediately felt. Global oil consumption drops from a pre-pandemic 100 million barrels a day to an estimated 88 million barrels a day in the first quarter of 2020.
The fall in demand was worrisome for worldwide oil producers, and Saudi Arabia set out to lead OPEC+ into a deal to cut production worldwide so that supply and demand would be balanced once again. Russia, however, declined to take part in the deal, which triggered a price war between Russia and Saudi Arabia. Russia had multiple reasons for declining to take part in the deal.
According to Russia itself, it wanted to see the full impact of the coronavirus on oil demand before taking action. However, others say that Russia believes the US would benefit the most from cutting the supply. Even though the US has grown into the largest producer of oil in the past decade, it has remained to be tight on margins, so falling oil prices could be a chance to hurt the US oil industry, according to people familiar with Moscow’s strategy. As one would expect, Saudi Arabia did not take this well and started increasing output and selling oil at a discount. In April, Donald Trump intervened and successfully eased the feud. OPEC+ cut a deal to start drastically reducing output starting May and decreasing it even further later in July.
It might be too little, too late, however. For the first time in history, US Crude Oil futures turned negative last Monday, as storage space is filled up quicker than it’s emptied. The reason that oil prices turned negative is that futures are closing in on expiration, where most traders will roll over into the next futures contract. This means that traders will sell their May contract and buy a June contract. As futures near their expiration date, futures prices converge with spot prices. It is expected that storage facilities will be full during May, and if travel doesn’t start to increase, oil could start getting halted in distribution, as oil is still underway to refineries, which don’t need it, can’t store it, or both.
So, what’s next for oil in 2020? Oil will start getting demand when travel is possible again, but nobody knows when that will happen. Of course, the OPEC+ deal to cut supply is still in place. However, chances are the cuts will happen too late. The deal will go into effect on May 1st, but by that time, much oil is still on the way to already full storages. It’s like “Turning off the tap while the bathtub is overflowing,” Helima Croft, global head of commodities strategy at RBC Capital, said on CNBC. It is now reported that traders are moving in on these events by leasing floating or onshore storage to store oil until prices rebound, to then sell it at a profit.
One can imagine the impact this price drop will have on the economy. Stock markets usually respond to oil price drops quite fast. A ripple effect on other companies is expected as well. Oil production companies are often highly leveraged. Once these companies start defaulting on their debt, the impact on banks will be huge, according to Jonathan Golub of Credit Suisse. The US government will probably have to step up again, but there can only be so many bailouts.