Five Things to Know About the Oil Market

Low gas prices come with a big downside.

April 28, 2020

ALEXANDRIA, Va.—The past week was devastating for the oil business, with oil prices falling to as little as negative $40 a barrel. While prices have since rebounded into profit territory, the industry is not in the clear. Here are five things to know about the wild swings, what may be on the way and why it matters, according to TheHill.com:

It’s a supply and demand problem.

Even before the worldwide pandemic took center stage, Russia and Saudi Arabia were feuding for market dominance, increasing their production and flooding the market with oil. The ill-timed production increase came as the virus began shutting down economies in Europe. Then the U.S. demand for all types of oil dropped 30% as people sheltered in place. U.S. supplies remain abundant even as oil producers have cut their production by about 5% during the past month. Continuing production is the only way for oil companies to make money, even if it just means their losses won’t be quite as deep. That causes another problem—oil companies are running out of space for their product.

There’s no place to store it.

That lack of storage space for oil has caused extreme market reactions. Traders rushed to free themselves of contracts for oil they weren’t physically able to take possession of. Not everyone trading oil contracts has the infrastructure to pick it up or store it—leaving paper traders scrambling to find buyers. The negative price reflected traders’ willingness to pay others to take their oil contracts and figure out what to do with the product. Though prices crept back into profitability last week, negative pricing could repeat itself because storage space is still so limited.

U.S. oil companies are sensitive to big price drops.

Low prices are particularly damaging for U.S. oil producers because of their reliance on fracking. Nearly all oil in the U.S. is produced using the method of forcing water and chemicals deep into rock crevices to push out oil. The process itself is more expensive, but fracked wells also bring more of their oil to the surface within the first year, with their short lifespan making each well much more tied to market prices. Oil producers could “shut in” wells, essentially allowing them to pause production, but beyond the other financial considerations, doing so risks damaging the well’s productivity. 

The short-term future of the oil industry is still unclear.  

While oil prices have lifted with the start of a new contract month, market conditions have not changed very much. There is still much more supply than demand. Earlier this month, OPEC agreed to cut oil production by 10 million barrels a day, a roughly 10% drop in the daily global supply. Those cuts don’t kick in until May, and so far, the agreement seems only to have helped stabilize prices for international benchmark Brent crude. The Trump Administration wants to open lines of funding for oil companies, but Treasury Secretary Steven Mnuchin said he faces legal limitations to doing so. The Department of Energy has begun the process of renting 23 million barrels of storage space to oil companies to be paid for in oil. But experts say the only surefire way to really start burning through the excess supply is by reopening the economy to increase demand.

Enjoy low prices, but understand the downside.

Low prices for crude have filtered down to the pump. Gasoline was selling at an average price of about $1.80 a gallon this week and fell as low as 78 cents a gallon at a gas station in rural Minnesota earlier this month. That may help consumers save when filling up, but the disruption to oil markets is a sign of larger economic woes. It also means losses on gas taxes and other revenue for cash-strapped state governments. It’s bad news for big oil-producing states that rely on oil to fund operations, and lawmakers from oil-producing states have repeatedly warned of the economic impacts of job losses within the 10 million-employee industry.

Even the climate may not benefit from low oil prices because it’s harder for other technology to stay cost competitive. “If gasoline prices are low, there’s a worry it will slow the adoption of electrical vehicles or other clean energy solutions,” said Tim Donaghy with Greenpeace.

In addition, plummeting energy demand during the coronavirus pandemic has decimated the ethanol industry, according to the Wall Street Journal.  U.S. inventories of ethanol have been building all year and have shot up as the pandemic keeps drivers off the road. Ethanol production has dropped to a record-low 563,000 barrels a day, the U.S. Energy Information Administration reports, and domestic inventories hit a record 27.7 million barrels as of April 17. Ethanol companies are losing nearly 20 cents on each gallon they refine, price-assessment firm S&P Global Platts said Friday.

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