As a rule I try to stay out of discussions about energy prices. Energy trading is a hectic business with a lot of stress, plagued by fleets of hot-headed issues that have nothing to do with supply or demand or technology. But that’s not the problem today. The problem today is the world is at the beginning of its sharpest economic downturn since the 1920s while the world’s largest oil exporter has launched a rage-driven price war. The end result is pretty straightforward:
Oil prices are going to, and through, zero. Sometime soon, probably before the end of May, oil prices will be negative. Pretty much everywhere.
Let’s begin with demand.
When coronavirus took parts of China’s economy offline in February, the country’s oil demand likely dropped by 3-4 million barrels per day (mbpd). As China has come back on-line some of that demand has regenerated, but it has been more than overwhelmed by the rest of the world descending into lockdown. With some 250 million Americans under some degree of stay-at-home order, US gasoline demand today is down by nearly two-thirds. Transport fuels account for about two-thirds of US oil demand, so that’s a headline reduction in oil demand of ~9mbpd.
From just one sector. In just one country.
Similar contractions in fuel demand have occurred in other locations where the virus has forced populations into cloister. And while not strictly petroleum-related, most locations under lock down appear to see electricity demand drop by one-third to one-half based on their industrial make up. The demand crunch isn’t just for raw oil, but for refined products as well. Throughout the world, refiners are either spinning their facilities down to the absolute minimum they can manage without shutting them down completely, shutting them down completely, or attempting to sell cargoes they’ve previously purchased to others rather than take actual delivery.
All told, as of March 31, the total decline in global oil demand appeared to be at least 15mbpd out of a pre-virus total of about 100mbpd. Even if the decline is “only” 15mbpd, this is the largest decline in demand in both absolute and relative terms in the history of petroleum, and it all occurred in under three months (with the bulk of it in less than three weeks
Which means the price drops we’ve seen so far are just the beginning. First, coronavirus only really shut down the U.S. and European economies last week. Second, meaningful economic contractions in India and South Africa are only happening now. Third, Japan, Mexico, Brazil and Indonesia have yet to enact meaningful social distancing. Demand has a lot
further to fall. Penciling in a total demand decline of 25mpbd seems eminently reasonable. Maybe even a touch conservative.
And demand will stay
down. Assuming you believe Chinese data and propaganda, a return from quarantine takes about two to three months. That suggests – assuming zero collateral economic damage – that the world should not expect a large-scale increase in oil demand to begin
until at least June. And even then there would be a ramp up period. (Any volunteers to be the first person back on a plane?) And as I discussed in the Epidemiology Guide
, three months offline may well just be the beginning.
So that’s demand. Now let’s talk supply.
The bottom line is that the Saudis are pissed.
Saudi Arabia has been the world’s largest oil exporter for decades, and for the past 47 years the Saudis have led most of the world’s major oil exporters – first within and then beyond OPEC – in regulating the global supply of crude oil. In recent years the player who has most mattered, and most vexed the Saudis, is Russia: the world’s second-largest net crude oil and second-largest refined product exporter.
The fiction is that the Russians cooperate. In reality, due to reasons climatic, geologic and geopolitical, the Russians have never once actually reduced output. The most Moscow has ever done is claim to cooperate and maybe do a touch extra seasonal maintenance, while then reaping the benefits of Saudi reductions. The Saudis know it, but getting the Russians to at least say
they are cooperating holds some value in the emotion-driven world of oil trading.
When conoravirus reduced Chinese demand in February, the Saudis realized prices were going to suffer and so sought to build another broad alliance to reduce output. Everyone signed on. Everyone, that is, except the Russians. In fact, this time the Russians refused to even make an empty promise (because they had plans to bring more
crude to market). So the Saudis scrapped the deal with everyone else, declared a price war in a huff, started bringing their spare production on-line, and started exploring their mothballed oilfields to see just how much oil they could dump on the market. That effort increased their exports by over 1mbpd during March, will increase them by an additional 2mpd by the end of May, with the possibility of at least that much again throughout the rest of the year.
There’s also a new factor in the mix: personality. Saudi Crown Prince Mohammad bin Salman (MBS) is the Kingdom’s new leader, having only been holding the reins about three years. Bit by bit he has been remaking the kingdom and its policies in his own image. His formative leadership years are occurring during the American withdrawal from the Middle East, and so he has come to the (correct) conclusion that Riyadh is going to have to look after its own interests more directly. That means more aggressive stances in places like Iraq and Syria and Yemen…and in oil markets. He is bold and brash and inexperienced and he doesn’t see the old way of negotiating collective oil production declines as working. He has a point.
So who wins this?
The Russians have about $560 billion dollars in financial reserves, but most of it is not
in US dollars. With the US dollar likely to go up during coronavirus
while everything else goes down, the Russians are likely to at least in part regret their decade-old anti-US financial campaign. Perhaps the biggest thing the Russians have going for them is that most Russians consider privation and suffering to be points of national pride. The Russians have to hurt, really hurt
, before they’d even consider giving in.
Saudi Arabia’s formal reserves are nearly as large as Russia’s ($500 billion) but Riyadh has access to other funds that are probably worth three times that. And from time to time MBS likes to liquidate this or that prince from the branches of the family that used to have the run of the Kingdom, and take all their stuff. The Saudi royal family literally has hundreds of thousands of princes, so there’s a lot of financial heft just laying around for emergencies like this one.
On April 2, the Saudis indicated they’d like to host another OPEC+ summit with intent of making emergency oil production cuts on a global scale. Consider what the scale of “success” would be. The largest cut OPEC+ has ever
made was less than 3mbpd, with the Saudis shouldering half the burden. It’d take a cut (at least) five times that to stop the downward spiral. It is difficult to see the Saudis even considering such unless the Russians don’t simply put some skin in the game, but also pre-commit a couple non-disposable limbs.
So that’s demand and supply. Here’s the time-frame:
With coronavirus gutting economic activity, refiners the world over are for now putting their extra product into storage, but they are running out of space. Governments and refiners both are taking advantage of low oil prices to top off their stored oil reserves, but they
are running out of space.
And the crude keeps coming. There are hundreds of millions of barrels of crude on tankers that have left the Persian Gulf and West Africa but have not yet made it to their customers because it often takes up to a month of sailing for Persian Gulf oil to reach a customer
. There’s a whole wave of oversupply shocks that will hit and keep hitting every single day for weeks to come.
At the beginning of the crisis total global spare storage capacity was likely about 1 billion barrels. Back of envelope math suggests all storage everywhere will be filled to brim sometime around mid-to-late May, again, assuming the demand decline does not increase above 15mpbd. If the true figure is 25mpd, we hit the wall a 2-3 weeks earlier. And when that happens prices go firmly negative.