On April 20, the price of oil crashed, dropping to the lowest level ever recorded and plunging into negative territory for the first time in history. By the close of trading, oil had dropped to -$38/barrel; that meant that sellers had to pay buyers nearly $40 to take a barrel of oil off of their hands. Traders and speculators watching the market had to rub their eyes to make sure they were seeing the numbers correctly.
As if the recent market selloff were not bad enough, shareholders in energy companies got walloped yet again, but the losses were not limited to energy: The entire market was rattled. But as shocking and painful as these developments were, some industry analysts warned that the worst was still to come. And in their view, another big selloff could materialize in the very near future.
If this forecast proves to be even partially correct, it raises several questions: First, how could the oil market get so wacky? Second, what implications would such a selloff have for the industry? Also, how might this impact the overall economy over the long term?
The answers are complicated, but they can be summarized simply: A rapidly weakening global economy is crushing demand while at the same time supplies are surging because of a no-holds-barred price war between two major producers.
Some consumers will be glad, because there will be lower prices at the gas pumps, but if so, they’re mistaken, because economies are surprisingly dependent on the oil industry. Many investors, companies, and countries will pay very dearly for the drop in price.
Fill ‘Er Up
Typically, the oil industry is shrouded in a great deal of mystery: Very few people really know how much oil-producing countries really pump each day. Nor is it clear how large company and country reserves are or exactly how much oil the world uses each day.
While industry sources have very different views, there is one point on which they seem to agree: Currently, there is an oversupply of at least 20 million barrels a day, and according to some, this number is actually much higher - over 30 million barrels per day.
Oil’s woes began even before the virus started to shut down the global economy; the price of a barrel of oil had already been declining steadily. The corona crisis accelerated this trend.
So did the price war between Saudi Arabia and Russia, two of the world’s largest producers. Both continue to pump oil at a furious pace and neither wants to be the first to blink and cut their production. As a result, inventories of oil are continuing to grow very quickly, putting more pressure on the price.
It’s gotten to the point that the world is literally running out of room to store all of the oil that’s being pumped. This is why oil has dropped to negative prices -purchasers locked into oil contracts had nowhere to store the oil they had purchased.
An Important Question
Are these developments the results of market conditions that got out of control, or are they part of a much bigger scheme, one hatched by the Saudis to destabilize the market and ultimately gain more control of it? There’s reason to believe this theory.
Consider this. As we write this:
*Dozens of oil tankers carrying at least 50 million barrels are on their way to the U.S. from Saudi Arabia;
*Many dozens of tankers off the coast of California are waiting for an opportunity to unload their cargo in the U.S.;
*There are hundreds of oil tankers off Singapore ready to do the same.
From Plenty To Shortage?
Oil companies were never structured to do business on an oil price as low as it is now, and they are literally losing money by the minute. If these fire sale prices persist, many, particularly the smaller ones, will not be able to meet their payrolls. Nor will they be able to make payments on their bank loans, and would then be forced out of business.
The analyst who predicted negative oil prices several weeks ago now forecasts an even bigger drop in the very near future. He believes that if this materializes, many hundreds of U.S. oil companies will be forced to close shop. The oil they produce now will be taken out of daily production, the huge surplus will gradually come down, and the price of oil will rebound.
If production stops at so many companies, restarting it will be difficult or impossible for technical and financial reasons - even if the price of oil ultimately goes much higher. In other words, once they stop pumping, their oil is gone forever. And oil companies in other countries will surely face the same difficulties.
Potentially, what all of this will add up to is a huge drop in global production. The U.S. and other countries will once again become more dependent on foreign supplies, much of it from the Middle East. The price of oil could then rise sharply. And foreign producers will demand financial and political concessions from the U.S. (and other countries) in return for their oil.
Does anyone still remember the long lines at gas stations? Does anyone recall fears about people freezing in winters because the price would be unaffordable? Is history about to repeat itself? Maybe, but there wouldn’t be a shortage this time, because the Saudis would come to the rescue, open their spigots to maximum, and sell the world all the oil it needs - for a hefty price, of course.
No one can say for certain that the oil crash is part of a spectacular Saudi scheme. Nor can anyone say for certain that this scenario will play out as some predict. Even the best analyses are subject to change very quickly. Financial models and projections that make sense on computer monitors often don’t play out in real life. And unanticipated developments happen often enough to upend even the best of plans.
But the fact that there’s even a premise that oil could plummet to all-time lows, pull down hundreds of companies, and subsequently skyrocket, and that triple digit oil prices could become a reality should give investors pause when planning their portfolios. After all, we’re living in an era when anything can happen. And very often does.