Unprecedented collapse of the oil market leads to negative prices for the first time ever

Back in March, I warned you about The Saudi Arabia-Russia oil war against U.S. oil producers (snippet):

Two of Donald Trump’s favorite autocrat buddies, Mohammad Bin Salman Al Saud of Saudi Arabia and Vladimir Putin of Russia, have decided to engage in a price war over oil in an effort to capture market share in Asia, and to force American shale oil producers out of business to reduce American market share.

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“Russia and Saudi Arabia stand to gain substantial market share by bankrupting the U.S. shale oil industry. And they know the U.S. producers do not have enough capital to withstand a large drawdown in crude prices.” Collapsing Crude Prices Will Bankrupt U.S. Shale Oil Stocks. When U.S. oil and gas stocks start going bankrupt, these two energy-producing rivals believe they stand to gain the most.

Producing a glut of oil in a global economy that was already beginning to contract before the coronavirus pandemic hit was driving the price of oil down. The global economy’s unprecedented lock down in response to the coronavirus pandemic only exacerbated the decline.

On Easter Sunday, Trump got his autocratic buddies together purportedly to make nice. Trump Hails OPEC+ Agreement As ‘Great Deal For All’:

US President Donald Trump on Sunday welcomed a deal by top oil-producing countries to cut output to boost plummeting oil prices due to the coronavirus crisis and a Russia-Saudi price war.

“The big Oil Deal with OPEC Plus is done. This will save hundreds of thousands of energy jobs in the United States,” Trump tweeted.

“I would like to thank and congratulate President Putin of Russia and King Salman of Saudi Arabia. I just spoke to them from the Oval Office. Great deal for all!”

You should always be skeptical of a con man when he is overly effusive in hyping his latest scam. The New York Times warned at the time, The Big Deal to Cut Oil Production May Not Be Big Enough:

The agreement by major oil producers on Sunday to reduce their daily production by 9.7 million barrels was the largest cutback in history and a feat of remarkable coordination by more than 20 nations led by Saudi Arabia and Russia with unusual mediation from the United States.

But it probably still won’t be enough.

Demand for oil has tumbled in recent weeks as the coronavirus pandemic has crippled global commerce and eliminated untold numbers of commutes, plane trips and cargo shipments. Experts estimate that demand has fallen by somewhere between 25 million barrels and 35 million barrels a day — or up to three and a half times as much as what the oil nations are promising to cut.

Leaders of the American oil industry, which is responsible directly and indirectly for roughly 10 million jobs, welcomed the deal and President Trump’s role in mediating a halt to a Saudi-Russian price war. But even they acknowledged that it would not end their financial difficulties.

“The problem is the demand is still not there,” said Kirk Edwards, chief executive of Latigo Petroleum, a Texas producer. “Even with these cuts there will be a tremendous amount of oversupply on the market, and that’s why you haven’t seen the oil prices dramatically increase.”

Sure enough, only a week later the previously unimaginable has happened: the global oil market has collapsed with oil prices declining into negative prices for futures contracts in May. “So much winning!”  Oil Spirals Below Zero in ‘Devastating Day’ for Global Industry:

The day started like any other gloomy Monday in the oil market’s worst crisis in a generation. It ended with prices falling below zero, thrusting markets into a parallel universe where traders were willing to pay $40 a barrel just to get somebody to take crude off their hands.

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West Texas Intermediate futures have been the benchmark for America’s oil industry for decades, seeing the market through booms, busts, wars and financial crises, but no single event holds a candle to this. By the end of trading, the contract had slumped from $17.85 a barrel to minus $37.63.

“Today was a devastating day for the global oil industry,” said Doug King, a hedge fund investor who co-founded the Merchant Commodity Fund. “U.S. storage is full or committed and some unfortunate market participants were carried out.”

On Tuesday, oil’s meltdown has spread further to future month contracts, with losses sweeping through markets as the world runs out of places to store unwanted crude and grapples with negative pricing. Oil Meltdown Spreads Past Expiring Contracts With WTI Collapsing:

West Texas Intermediate plunged below zero on Monday for the first time in history as May futures neared expiration, leaving traders in a panic as they tried to avoid taking delivery of physical barrels. On Tuesday, the losses spread to the following month’s contract — highlighting that a massive supply glut is driving the rout rather than a technical quirk.

The Texas Railroad Commission opted to put off a decision on whether to impose oil-production quotas. The state’s main energy regulator said it would not take a final vote on curtailing output during a closely-watched Tuesday meeting.

The collapse of later contracts underscored the severity of the crisis rocking oil in the age of coronavirus. Storage tanks, pipelines and tankers are rapidly being overwhelmed by a vast oversupply caused by slumping fuel demand as countries are locked down to contain the pandemic.

A lot of retail investors, especially those in the USO, after witnessing what happened to the May contract are trying to get out fearing that the same will happen in June[.]

WTI for June dropped as much as 46% to $11 a barrel at 12:35 p.m. in New York. The thinly traded May contract rallied to $4.04 a barrel after settling in the previous session at minus $37.63.

The oil and gas industry shed nearly 51,000 drilling and refining jobs in March, a 9% reduction that is likely to get worse. The Oil Industry Shed 51,000 Jobs in March (And Things Look Set to Get Worse):

An unprecedented output deal by OPEC and allied members a week ago to curb supply is proving too little too late in the face a one-third collapse in global demand. With no end in sight, and producers around the world continuing to pump, that’s causing a fire-sale among traders who don’t have access to storage.

BW Research projects oil and gas jobs could decline by as much as 30% in the first quarter of 2020.

The industry has faced the twin shocks of the coronavirus crippling demand with stay-at-home orders coupled with an oil-price war between Russia and Saudi Arabia that led to a glut and sent the price of oil spiraling to historic lows, leading U.S. companies to idle drilling rigs.

The oil industry can’t cut oil jobs fast enough to keep up with a market that Halliburton Co. described Monday as being in free fall. For every rig or fracking crew that gets cut, roughly two dozen field workers lose their jobs.

The cuts range from giants like fracking-services provider Halliburton, which last month furloughed 3,500 workers at its headquarters in Houston, to Oklahoma-based Recoil Oilfield Services LLC, which cut 50 workers after losing its work with shale giant EOG Resources Inc.

Oilfield servicers are hardest hit, as roughly 20 companies are employed at each well site. As the explorers who own the wells file for bankruptcy, their pain spreads throughout the supply chain.

By the way, the coronavirus pandemic has also hammered clean energy employment:

BW Research released a report last week that showed clean energy workers — such as solar panel installers and electric vehicle manufactures — lost more than 106,000 jobs last month. Overall, energy-related jobs fell last month by more than 303,000, the firm said.

Economics analyst Neil Irwin at the New York Times says we are witnessing a deflationary shock (a harbinger of depression). What the Negative Price of Oil Is Telling Us:

The coronavirus pandemic has caused a series of mind-bending distortions across world financial markets, but Monday featured the most bizarre one yet: The benchmark price for crude oil in the United States fell to negative $37.63.

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There are two ways of looking at this. First is what happened in a technical sense. The collapse of the May futures contract for West Texas Intermediate crude oil shows how the shock of the crisis is rippling through all sorts of markets and making them behave strangely.

But the broader takeaway is that the Covid-19 crisis is an extraordinary deflationary shock to the economy, causing the idling of a vast share of the world’s productive resources. Don’t let shortages of a few goods, like face masks or toilet paper, confuse the matter. The consequences will almost surely persist beyond the period of widespread lockdowns.

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Tuesday is the settlement day for that May [futures] contract. It fell from $18.27 at Friday’s close to the steeply negative numbers late Monday amid a frantic effort by traders to offload oil for which there simply wasn’t enough physical demand or storage capacity.

Over the last six weeks, demand for products refined from oil has collapsed. With far fewer airplanes flying, airlines need less jet fuel. People aren’t driving, so they need less gasoline.

But oil producers have been slower to cut back production, meaning there is a glut. All the usual places to store it are full, and hence the negative futures prices to enable the market to clear. There are only so many storage tanks.

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All of that points to a deflationary collapse — a glut of supply of goods and services, and consequently falling prices — that surpasses anything seen in most people’s lifetimes.

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In the oil market, even assuming the negative prices for the May futures contract can be viewed as a bizarre aberration, there is a deeper lesson. A steep rise in American energy production over the last decade has outpaced the world’s need for energy, especially if many of the changes resulting from the pandemic, like less air travel, persist for months or years.

Economics is about supply and demand, production and consumption. The question for the post-pandemic economy is whether that balance, once lost, can be quickly restored. Doing so will be a lot more complicated than finding more places to store West Texas Intermediate crude.

Many U.S. oil producers are heavily leveraged, and if they default on their debt and go into bankruptcy, the banking/finance industry is going to be next. These U.S. oil companies are most at risk in the danger zone (excerpts):

U.S. oil producers are reeling from a vast reduction in demand from the coronavirus shutdown, but also from the decision by Saudi Arabia and Russia to increase output.

At a time of plunging cash flow, highly indebted oil companies will do everything they can to shore up liquidity, lower production and cut any costs they can.

The S&P 500 energy sector has already dropped 43% this year through April 17. That is, by far, the worst performance among the S&P sectors, with the full S&P 500 Index US:SPX declining 11%.

Despite that tremendous decline, nobody can say for sure when oil demand will recover sufficiently to take highly leveraged U.S. producers out of the danger zone.

To take a broad look at the energy sector, the following list is derived from the S&P 1500 Composite Index, which includes the S&P 500, the S&P 400 Mid Cap Index US:MID and the S&P Small Cap 600 Index US:SML. The S&P 1500 energy sector includes 82 companies. Here [are] the 30 with the highest ratios of net debt (total debt minus cash) to total capital[.]

The oil price collapse is going to ripple through other sectors of the economy, causing further economic disruption and unemployment. This is only the beginning.