By Marshall Auerback, a market analyst and commentator. Produced by Economy for All, a project of the Independent Media Institute
When a staple commodity collapses to negative value it signals that something is clearly amiss in the global economy. When it is a global energy source like crude oil, it does not just signal pain in the oil patch, but an economic dislocation evocative of the Great Depression. Rare is the time when a commodity over which nations have fought wars in the past presents itself as something that traders would literally pay you to take it off their collective hands.
To be sure, there are good technical reasons why U.S. West Texas Intermediate crude oil (WTI), the underlying commodity representing the NYMEX’s oil futures contract, actually traded negative in the second half of April, and continued to stay low (even though the June contract has now turned positive). Put simply, there is virtually no storage capacity left for a supply glut of the commodity, which likely puts a cap on the price, especially in a world of virtually nonexistent demand. That doesn’t mean you’ll be getting paid any time soon to fill up your car the next time you choose to fill it up with gasoline, or even rewarded for storing some in your swimming pool; after all, Brent Crude, the North Sea oil that serves as a benchmark to the majority of worldwide oil markets, is still trading around $20/barrel. But the economics of production have radically shifted against a huge number of deposits. How does the oil industry respond to these challenges?
Oil wells aren’t like sink faucets; if you stop the flow, it’s a lot of work to get the systems running again. And many oil-producing countries and private companies live basically paycheck to paycheck on sales to pay their bills. Economic pain in the United States will lead to more mergers and consolidations across the oil and gas industry, and, for the world’s leading oil export producers, difficult choices to privatize more of their nationalized industries to foreign buyers like China and Western petroleum companies.
For many countries that have relied on crude oil for export revenues, notably most of the OPEC countries, the collapse in price spells big trouble. In addition to the largest swing producer, Saudi Arabia, there is Iran, already suffering from the twin ravages of harsh U.S. economic sanctions and a massive outbreak of COVID-19. Venezuela is in dire straits. These are countries with debts to pay off, and investments that require steady—and predictable—flows of capital to sustain.
Russia, to its credit, has developed a strategic hard currency position that can see the country out of price crashes, and oil revenues are just cash on the barrel. Its economy is far less exposed to international finance, but still vulnerable as it does not have a mixed export economy. Leaders in these countries will likely have to make some devil’s bargains with China, Germany and Western oil majors and the IMF just to stay afloat.
The United States has had so many oil-price crashes in its economic history that dealing with another one is a matter of bureaucratic and financial muscle memory: a matter of forcing mergers for future efficiency, renegotiating debt and subsidizing the idle workforce. While the oil and gas companies may not volunteer to merge on their own at a time when their core products have cratered in value, banks and governments will see the value in simplifying the playing field.
Major net importers like India, Turkey or China should benefit only somewhat, as they only can store so much oil, so the effects of any consumer stimulus are limited, given storage capacity constraints and the fact that the entire global economy is still shut down.
We’re now experiencing the legacy of Saudi Arabian Crown Prince Mohammed bin Salman’s ill-conceived attempt to flood the markets with oil in the hopes punishing Russia (which had previously refused to support Saudi Arabia’s decision to cut production to elevate prices), and the American shale-oil industry, “whose burgeoning output had transformed the United States into the world’s biggest oil producer and one of its biggest oil exporters,” writes Eric Reguly of Canada’s Globe and Mail. How did we get to this point?
Crude oil is mostly traded between producers and refiners on futures markets. The refiner is the buyer of futures; they need to take delivery of the commodity, and they need to have some predictability about price and supply stretching out over many months. The seller of the future is the producer, the oil company that has pumped the black stuff out of the ground, and similarly they are selling their product at a price that will cover costs and be profitable. Then there is a third category of participant, the speculator, that has no interest or capacity in taking delivery of any oil, but just wants to profitably express views on the direction of the price (this source of demand has rapidly expanded over the years, as investment banks have created all kinds of new investments in commodity-linked products—China’s biggest bank has just suspended all new retail investments in products linked to oil and other commodities because their investors were taking huge losses in them).
In theory, the speculators help ferret out errors in the calendarized price structure of the trading model, but as we have all experienced, it is typically the speculators that distort the true price and value of our commodities. And they are the ones that gave the world the bizarre negative pricing phenomenon in the WTI markets earlier this month. Any trader buying a WTI oil futures contract commits to receiving a tanker full of oil in the next couple of weeks. The problem is that demand for oil products globally has collapsed—no flights, no factories, dramatically lower car usage.
At the same time, oil producers have continued to pump at levels that do not reflect the new demand paradigm, thanks to the decisions taken by Saudi Arabia weeks ago. Even though the Saudi crown prince and Russia came to a recent agreement to cut back production, the impact of the cutbacks will not come for weeks and in any case is insufficient, given the wholesale cessation of global economic activity. That means seeking refuge in a future oil contract won’t be easy.
Coming up to the expiry of a future, as a buyer, you have three options. You can keep the contract through the expiry point and subsequently receive oil. You can sell the contract before expiry and release yourself from obligation. Or you can roll your contract to next month, delaying your obligation, by selling this contract and buying next month’s. But even in the case of the third option, if you’re buying oil futures via leverage (as many speculators are doing these days), you face the risk of margin calls as and when the price declines.
What happened recently is that a lot of late buyers of oil found that there was no liquidity, no new buyers, to sell on to. After all, you can only take advantage of a ridiculously cheap oil price if you have somewhere to store it. To be sure, WTI contracts represent only a very tiny fraction of oil output globally, and do not fully capture the underlying supply and demand situation. But we do know that storage in the U.S. is at full capacity; otherwise, there would have been ample grounds for new buyers to arbitrage away the negative prices. That such a process has not yet occurred suggests a world swimming in oil. Oil producers likely must dramatically slash production to accommodate collapsing demand and nonexistent storage. We know that with such a glut, oil prices are going to remain extremely soft for the foreseeable future.
For years, the U.S. shale patch has been sustained by Wall Street-driven Ponzi financing, in which drilling and production for natural gas have not generated cash flows that come even close to offsetting costs of the debt service. The latest collapse should finally constitute the death-knell for this sector, even as the president and the GOP in particular (which largely represents American oil-producing states) scramble to provide funding to the sector. Storage capacity will take several months to build up and, at a time of increasingly fraught relations between the United States and China, the latter is hardly likely to do U.S. oil producers any favors, particularly when there are ample other (geopolitically friendlier) sources of crude in other parts of the world, which are also far cheaper.
In the past, such collapses in conventional energy sectors would represent a disaster for the renewables, because historically the latter have been viewed as economically viable only in an environment in which fossil fuel prices were becoming too expensive. But the economics for alternative energy sources has significantly improved over the years. Additionally, the very lack of a need for storage in wind and solar means they are facing far less collateral damage than crude and its related products. As Robin Harding of the Financial Timesnotes, they “have minimal operating costs and generate power as long as the sun shines and the wind blows.” Their challenge is the intermittency of supply, not storage, so there are challenges fitting the output curve to the demand curve.
Of course, this whole situation is unlikely to have happened in a country with a coherent national industrial policy that would have otherwise regulated other policies in the interest of its designated domestic strategic sectors and supply chains. Ideally, countries do not want the energy costs of manufacturing, along with other inputs, to vary wildly and unpredictably. A country with a rational industrial policy would combine buffer stocks with some sort of national quota and price support system to modulate the price of oil and gas. Since that could only be done on a national (or bloc) basis, it would be incompatible with a genuinely free global market in oil and gas—though of course there could be trade.
This is in fact what OPEC sought to do when the oil-producing nations effectively seized control of the global oil market (superseding the price-setting powers of the old Texas Railroad Commission). But as the United States lost control of the oil market, it became a national foreign policy goal for many years to destroy the oil price cartel and re-establish U.S. energy independence (even as the country continued to envelop itself in Middle Eastern affairs, the Carter Doctrine declaring that the United States would use military force, if necessary, to defend its national interests in the Persian Gulf). When the shale oil revolution began, we listened to shills for the finance industry who told us to put our faith in Mr. Market (but that didn’t stop U.S. foreign policy adventurism in the Middle East).
The collapse of the crude oil market today presents different kinds of challenges. Forget the idea of shale oil/gas reviving. Much like Monty Python’s “dead parrot,” there is no chance of reviving a sector whose economics were marginal at best, even when the oil price was much higher. Thanks to the coronavirus, these questionable economics (and correspondingly high depletion rates associated with the deposits) will kill the industry. Bargain basement shale gas prices, a byproduct of credit bubble finance and shale oil production (which enabled operators in aggregate to generate positive cash flow, even though the natural gas outputs in isolation were otherwise non-economic), will disappear. From the point of view of carbon emissions, this is an unfortunate development, given that cheap natural gas has catalyzed the transition away from dirtier forms of energy, such as coal.
Even if there weren’t a coronavirus pandemic, it would still be a peculiar moment for the global energy market, where many conditions are rapidly changing. The debt-fueled shale oil bonanza has hitherto enabled the U.S. to flood world supply and weaken the revenues of perceived geopolitical rivals. That leverage is now gone. Furthermore, as John Dizard of the Financial Times has observed, “Asian LNG prices have collapsed much faster than U.S. prices. That means it no longer pays to chill American natural gas, load it on to LNG tankers, ship it across the Pacific, and re-gasify it. So U.S. LNG exports are ex-growth.” That shifts the balance of geopolitical power in the energy markets in the near and mid-term back to countries like Russia and Tajikistan, as they are likely to re-establish a pipeline primacy that it looked like they had lost.
By the same token, the relative position of the major oil-consuming economies has improved. And all the petroleum producers continue to see their necessity undermined by the day with the growth (and rapidly improving economics) of renewable energies, climate change policies that encourage de-carbonization, and what looks like a rebirth of the nuclear industry. Although Russia and China now dominate the export of nuclear power plants, national security considerations are likely to push the United States more aggressively toward reviving its own nuclear industry. Uranium could over the next decade join the cadre of traded energy commodities with crude oil and natural gas as a geopolitical flash point. In any case, there is no need to lament the loss of a phony U.S. energy independence, which was built on the mirage of a credit bubble that artificially skewed the market toward otherwise uneconomic and environmentally degrading modes of production.
We are going to see a new set of political imperatives guiding the energy policy of the industrialized world. Much like needed medical supplies, or sensitive high-tech developments, new crude realities will force a similar discussion over national interest versus overreliance on multinational supply chains, as well as forcing ugly geopolitical compromises, vast increases in research and development, and a growing distaste for being at the mercy of any one energy source.
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Excellent post. Among the many problems of using nuclear energy is that the fuel it uses is in short supply. Which is to say there’s enough to build about 1000 plants world wide, yielding maybe 50% of the current electrical load. Not helpful if you want every car, plane, and house to go electric. I’d be remiss to say that there is an exception and it is to use breeder reactors, which produce bomb grade Plutonium. A 1000 much plants world wide is just another way to say we are committing to blowing ourselves up. No sane civilization would do this. The way I see it it’s either climate heating or nuclear disasters that will wipe us out. We have to deal with both. By my math we have only 50/50 chance of being able to survive if we do everything right and in place by 2050. I’m not stupid, I read my own words, and wonder where the will to deal with this is going to come from.
About 10 years ago I read that if the developed world went 90% nuclear, like France is/was, then we would run out of Uranium in about 100 years. There’s about 1000 years of Thorium, but developing an economically feasible Thorium reactor is proving to be a challenge. 100 years is a good amount of time to figure out what to next. As for the whole melt-down issue, a major accident every 20 years is far better then 6+ degrees of warming.
The problem with talking about any of this stuff is there are a lot of maybes involved, and the dependencies are unbelievable complicated. I’m at the point where the limiting action to do any of this and do it safety is of course with human judgement. But which I mean good human judgement. To be clear we can’t have a 6° C rise in the global temperature. And that can be stopped with what we know now. We just stop doing a bunch of “stuff”. Does everyone need a car, does anyone? It is a question that needs to be asked. I would image the answers will be individual, local, state and maybe a government if we had one. But, I don’t believe that people are willing to first solve the problem as it were and then solve it right. You know the enemy of good enough is always better.
Agree with this. Nuclear has to be seen as a transitional fuel. At a minimum, we should be replacing the old stock of US plants with newer ones that have superior technology. Indian Point has long been a disaster waiting to happen. IMO, I don’t think one can really be serious about reducing carbon emissions and and climate change without having nuclear as part of the equation, even if only for a century or less.
Putting aside for the moment the inevitable accident/contamination and waste storage issues, why on earth would we want to pursue a technology that, in the immortal analogy of Amory Lovins, involves using a chain saw to cut butter (i.e. go to the lengths of mining, processing, transporting and using enriched uranium to boil water?)
We don’t seem to be very capable of building commercial nuclear plants these days. See the Vogtle plant in Georgia:https://en.wikipedia.org/wiki/Vogtle_Electric_Generating_Plant .
“The certified construction & capital costs incurred by Georgia Power for these two new units were originally $14 billion, according to the Seventeenth Semi-annual Vogtle Construction Monitoring Report in 2017.[11] This last report blames the latest increase of costs on the contractor not completing work as scheduled. Another complicating factor in the construction process is the bankruptcy of Westinghouse in 2017.[12] In 2018 costs were estimated to be about $25 billion.[3]”
This follows a number of abandoned projects in other states because the economics weren’t there.
Westinghouse, the designer of Vogtle was purchased by Toshiba and was driven into bankruptcy by, among other things, the excessive costs of the project.
Seems like a dinosaur technology foisted on the world by WW2 and the boomers who made ka-ching from it.
The plant was the first one built since 3 mile island in 1979. We have lost our technical and industrial skill in building these. Add that to the litigation monstrosity that our politician/lawyers have created and it is no wonder. We are doing OK with submarine sized reactors…..to a degree. It is irrational fear in that far fewer people have died from nuclear accidents than from coal burning plants and when you count the money thrown at corporations in the last couple of weeks these plants were cheap. And France does use fast breeders. And there is risk of proliferation since there seems to be a link between the French nuclear program and Pakistan and Israel. So ultimately do we want population control or do we want nuclear? With half the world population we have now we probably could get by without nuclear. With another 3 or 4 billion in a few years we are going to need it or we are going to fry. China is going full bore nuclear with the new Westinghouse design, as I understand it. We will have to bring them over here to build our plants since they have developed the expertise. We are experts in llitigation and finance not building big projects especially nuclear.
Because realistically we do not have any other choice right now.
Saying that doesn’t make it so: please provide some evidence for your claim.
Lovins’ analogy speaks to the net thermodynamic and economic disutility of nuclear power (ignoring the very real disaster/contamination issues, testified to by private insurers refusing to cover the industry); are you challenging its validity? If so, please help us out and provide a credible rebuttal, and not a “just so” statement.
Marshall — why is Indian Point “a disaster waiting to happen”? It has long been (since September 2001) the claim of Westchester environmentalists that IP is vulnerable to a terrorist attack. But that aside, what about IP is uniquely dangerous relative to other nuclear plants?
Very good article, but I’d quibble with this statement – there are varying ways of calculating global warming impacts (as methane and CO2 behave differently), but I don’t think any of the assessments I’ve seen rate natural gas as ‘cleaner’ in terms of climate change than coal. This is especially so now that we know that calculations on methane leakage were far too kind to the industry. Even with best case assumptions (very low leakage of methane, plus extensive use of CHP), natural gas is only marginally better than coal.
The argument gets a little more complex when it comes to assessing the overall impact on electricity generation. CCGT gas plants are inherently more flexible than big thermal coal (or nuclear) plants, and so are more complementary with renewables (and nuclear, for that matter). A wind/solar and gas mix works much better than a wind/solar and coal mix. Likewise, gas is essential for a nuclear heavy grid as its needed for peak energy provision and to stand in if and when the nuke plants go down (they have a nasty habit of going down simultaneously.
To give a current example, Ireland lost its coal baseline power output this winter due to a accident at the main coal thermal plant back in October. But this didn’t create any problems – in fact Ireland was a net exporter, thanks to a very windy winter which meant that a gas and wind and storage combination worked very well. So yes, gas is very important in a transition to a renewable system, but it is not in itself superior as a raw energy source to coal when compared unit by unit to coal.
+1
Some reactors, such as Canada’s Candu nuclear plants are capable of being run in load following mode and have been due to the increase share of renewables in Ontario.
The major downside of the Candu design is that they are more expensive up front (heavy water ain’t cheep after all), even if they have lower operating costs and have more inherent safety than the boiling water reactors and pressure water reactors that are common across North America.
I am trying to see the effects of this but they are so wide spread. I understand that both Saudi Arabia and Qatar are both going for loans so their finances must really be in the toilet. Iran is in no position to take advantage with Qatar as they have their own problems. I would guess that the other Gulf States are also in the hurt locker.
That bizarre idea of having a fleet of LPG ships carrying American gas to sell in Europe I would suppose is a dead duck. Not only then will Nord Stream 2 be finished but the planned Nord Stream3 will now go ahead. As far as Germany is concerned, countries that protest this like the Baltic States and Poland can go pound sand. They need that gas from Russia now.
If the US will almost soon be a net importer of oil, Venezuela had better watch their backs as the temptation will be too great for the Pentagon to solve this problem by seizing another country’s oil fields. What’s Spanish for Vietnam 2.0?
The real problem is that oil is at the beating heart of our civilization. It makes everything from gasoline, distillates such as diesel fuel and heating oil, jet fuel, petrochemical feed stocks, waxes, lubricating oils, asphalt, clothing, plastic, etc. Google says that there are some 6,000 products made from oil so if there is anything that should be stabilized both in terms of demand and price, you would reckon that it would have to be oil, especially in light of the fact that the easily recovered oil is now running out. But instead, we have this cluster*** which is made worse by the fact that it did not have to be this way at all.
“If the US will almost soon be a net importer of oil…”
According to the EIA, the US is already there:
“The resulting total net petroleum imports (imports minus exports) were about 0.53 MMb/d in 2019.”
I wonder what proportion of our stock market is held by the Saudis. What proportion of our big banks is held by Saudis or Saudi proxies? When we bail out these institutions are we supporting the share price for Saudi Arabians and if so to what degree? What lobbyists are pushing these bailouts?
The US has been a net importer of crude oil for decades and will continue to be one for many more. The export number in the link you posted includes ~5 million barrels of refined products and natural gas liquids per day. at the peak in late 2019, the US was producing ~13 million barrels of crude (though a lot of it is really too light to be considered truly “crude”) oil and their refining capacity is slightly less than 19 million barrels of oil per day. subtract the 3 million b/d of crude they export (largely because it is too light for their refineries to process) and you have a significant requirement to import crude. Going forward, that requirement is going to grow as production of crude in the US will drop to less than 9 million b/d (IMO) as production is shut in and capex budgets are slashed and external capital dries up (absent some massive increase in $$ it will never get back to that 13 million b/d high water mark). It will take a significant period of time to work through the bloated inventories of both crude and refined products, but it will happen as cheap energy will be required for countries around the world to dig out of a very deep covid19 induced recession.
This extreme volatility we are seeing today will sow the seeds of a supply shock at some point down the road as cheap crude and refined products in the near term will increase consumption (post covid lock downs) and the extreme financial stress at the producer level will hurt their ability to increase supply. Supply issues may take a few years to show up, less if/when governments around the world try to stimulate their economies with massive infrastructure projects (which i fully expect to happen as it becomes obvious that bailing out the stock market doesn’t do a lot for the actual economy).
Thank you for the interesting article. I have been thinking a lot about what all of this will mean for renewable development and countries’ climate ambitions. I wonder how many and which of all of the predictions will turn out even remotely true. From what I can tell we are really only in the end-of-the-beginning of this, and where we go next is anyone’s guess. I worry the climate people are making sweeping statements based on what will in large part only be short term trends.
Excellent article although Marshall seems to have missed the change in the shale industry from fracking for methane (which was never really the object) to fracking for natural gas liquids for the production of plastics. This is being accompanied by a massive current and planned build out of ‘cracker’ plants along the Ohio River Valley and again along the Gulf coast. These are tremendously environmentally destructive operations, but highly profitable for the petroleum plutocrats who are seeing the writing on the wall for oil and its derivatives. These operations are already poisoning the air and water wherever they are located and will spell disaster for communities and regions for decades to come.
Do you have links or more information on the “cracking” plants? Is this really separate from methane (natural gas) production? What are natural gas liquids?
I’ve liked this site’s journalism on it, here is a recent article.
There is no particular evidence that the plastics plants will be profitable – in fact, there is plenty of evidence that they have massively overbuilt capacity. They are essentially hoping for an endless increase in demand for plastics. If the price of gas ultimately goes up if and when the fracking industry collapses, that investment will be doubly bad, it has all the makings of a calamity for the industry.
Ideology dissipates. Maybe under the weight of its own complexities. There are no simple ideas under the sun. Because everything is physically connected. Good thing computers are getting smart enough to juggle the future for us. All those variables. All those permutations. “The Market” has been such a blunt instrument. It’s embarrassing to think we ever even considered it to be our regulator. It has only functioned because we had miles to go until our machinery got clogged. Our market, our financial system, is a one trick pony – Demand. Ironically, because the way we talk, it sounds like the trick is manufacturing. But it is demand we are constantly trying to create and control. Advertising. Mindless peer pressure. Scarcity. Hoarding. Interest rates. “Liquidity” itself is demand. Just a prettier word. That governments and banks join forces to maintain supply isn’t very “free market” – banks functioning as virtual warehouses storing hoarded commodities – government pretending it isn’t nationalizing the economy because there are tradeoffs like turfing 10 million people out of their houses and giving the houses to banks or private equity. Did that actually support demand for housing? But when everyone no longer cares, please tell me how they hoard, warehouse and nationalize an ideology. The MSM is absurd. Nobody pays attention to Congress because it is incapable. Trump is just entertainment. One good pandemic and it’s all over.
Isn’t the Ponzi-financed fossil fuel industry just a mirror of our not-so-real economy–one that exploits our national identity as consumers?
Should the US financially distance ourselves from outsourced manufacturing and international supply chains mired by huge carbon footprints to socially approximate requirements for manufacturing of basic domestic needs–like the N95 masks?
Can we make a just transition from fossil fuels without nationalizing this industry?
How do we transition to “clean” renewables if “Planet of the Humans” arguments that solar and wind aren’t so clean has validity? The movie didn’t touch on hydrogen, but it’s not a perfect energy source at this time because it relies so heavily on fossil fuels as well.
Sigh!
Nonsense. Intermittency is a challenge if and only if storage is a challenge. This is true for all types of energies, not just wind and solar. The current « oil crisis » is a storage crisis, which will morph in a production crisis because shutting in wells damages them.
In that matter, fissile material such as uranium have a huge Storage advantage :
– they only account between 2 and 10% of the energy production price (the rest being to pay for the expensive plants for fuel making, electricity production and fuel recycling). Therefore the pure financial cost of maintaining a storage buffer is comparatively small.
– they are a million times more compact (“million” is not rhetorical here, it is about the correct order of magnitude…) , so storing months or even years of consumption is not a logistical challenge, as for oil.
In an economy centered around fissile energy production, central banks would be the natural holder of fissile material buffers, ensuring security of supply and demand and ensuring that price swings of the stuff are negligible.
Well, there is also the storage of the nuclear waste to be considered.
North American oil is an odd duck in the world.
The Permian basin is developed in an area with ready access to pipelines, storage, and refining. However, most of the rest of the North American oil production is not in that position. Much of it is inland (Alberta, Dakotas etc.) and they have been struggling to get pipelines permitted and built to get to storage and refining. So you have the odd situation of coastal port refineries getting oil floating in from overseas, probably bought based on Brent pricing while interior oil is stranded with very high transportation costs pushing its price down.
Other oil producing countries either have their oil production largely offshore (North Sea) with easy access or are in countries that don’t bother with permitting (Saudi, Iran, Iraq, Nigeria, Russia, etc.). So if they want to get oil from Point A to Point B, they build what is necessary.
So basically, much of North American oil reserves are basically a Second or Third World product stranded in a First World permitting and legal system. So even in the best of times, many oil fields were struggling to do well, especially with the relatively high costs of heavy oil or extracting oil by fracking. You get an oil demand shock and there is little pricing flexibility and storage does not match up with where the oil starts out. So I think the North american oil market is going to get hit harder than the other countries, even if the economic shock is greater to the other countries because they are more dependent on oil.
Natural gas has much better distribution systems in North America and shouldn’t be hit as hard as oil, other than on supply and demand pricing in general.
The US is trying hard to export LNG, so shale gas is already in oversupply and (depending on the well), the overwhelming majority of shale gas wells require prices over $50 a barrel for oil, and some over $70, to be economical.
why does it matter what the price of oil is when you’re talking about the economic viability of a shale gas well? do you mean shale oil well?