Five things to know about the turmoil in the oil market

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Even for an industry already hard hit by the coronavirus, this week has been particularly devastating for the oil sector.

Oil markets had a historic first this week when prices fell so low that they turned negative, falling to as little as $ 40 per barrel.

With negative prices, crude oil fell more than $ 100 this year, down from around $ 60 a barrel at the start of the year.

Prices have since rebounded in profit, but the industry is far from clear.

Here are five things to know about wild swings, what can happen and why it matters.

Overview: a supply and demand problem

Long before the virus took center stage, Russia and Saudi Arabia competed for market dominance, increasing production and flooding the market with an overabundance of oil.

The untimely increase in production came when the virus began to close economies in Europe and then in the United States.

The demand for all types of oil has now dropped by 30% as people have settled there.

In the United States, however, supply remains plentiful, as oil producers have cut production by about 5% in the past month.

There is a method to their madness. Continuing production is the only way for the oil companies to make money, even if it just means their losses won’t be as great. They are also worried about reducing production to the point where they will not make enough money once prices improve to start drilling new wells.

But these two factors have led to a very real problem – the oil companies are running out of space for their product.

A fear of being saddled with oil and no place to store it

The lack of storage space caused extreme reactions from the market on Monday as traders rushed to free themselves from contracts for oil they were not physically able to take possession of.

Traders have until around the 20th of the month to buy and sell oil contracts.

But not everyone negotiates oil contracts doesn’t have the infrastructure to pick it up or store it – letting paper traders scramble to find buyers who can store oil.

The negative price reflected the willingness of traders to pay others to take their oil contracts and know what to do with the product.

“Once the month has passed, if you have not closed your positions, you must go to delivery, and if you are not involved in the physical market and have no way to make or take delivery, you are caught at the whim of those who trade in both the physical and financial markets, and that is what caused the negative prices, “said David Braziel, President of RBN Energy.

Although prices returned to profitability again on Tuesday, negative prices may well repeat themselves as storage space is still very limited.

Rystad Energy estimates that there may be only 21 million barrels of free storage left in a country that still produces 12 million barrels of oil per day – a feature that will certainly keep prices low.

“We saw negative oil at $ 37, so it is a punch in the face that reminds us of what can happen,” said Jim Burkhard, vice president and responsible for oil markets at IHS Markit. “So some investors have seen what can happen and are likely to learn from it, which could prevent a new wave of deeply negative prices, but with such an imbalance between supply and demand, it could happen again . “

US oil companies are particularly sensitive to sharp price cuts

These low prices are particularly detrimental to American oil producers due to their dependence on hydraulic fracturing.

In the United States, almost all petroleum is produced using the controversial method of pushing water and chemicals deep into rock crevices to extract petroleum.

The process itself is more expensive – it could cost up to $ 10 million to drill a fractured well versus $ 2 million for a well with a conventional derrick.

But fractured wells also bring more of their oil to the surface in the first year, their short lifespan making each well much more tied to market prices.

“The best day of life for an oil and gas well is its birthday,” when oil rushes to the surface, said Raoul LeBlanc, an oil industry expert with IHS Markit, at The Hill. But after that, “They keep declining. “

Oil producers could “close” the wells, essentially allowing them to suspend production, but beyond other financial considerations, this could adversely affect the productivity of the well.

Even if prices rebound, the short-term future of the oil industry does not look good

While oil prices have increased with the start of a new contract month, market conditions have not changed much otherwise, that is, there is still much more supply than request.

And the efforts that sought to change that couldn’t make enough difference.

A coalition of oil-producing countries known as OPEC + agreed earlier this month to cut oil production by 10 million barrels a day, down about 10% from global supply daily.

But these cuts do not begin until May, and so far the deal seems to have only helped stabilize international benchmark crude prices, as European supply is closer to most of the countries in the world. ‘OPEC +.

The Trump administration has also asked cabinet agencies to consider opening funding lines for oil companies – something that has also been demanded by many Republican lawmakers. But the secretary of the Treasury Steven MnuchinSteven Terner MnuchinSunday gives an overview: leaders intervene while certain states are reopening their economies; Biden deliberates that a fellow traveler US airlines get an additional $ 0.5 billion in federal payroll support The IRS announces a deadline for SSI, VA recipients to quickly receive stimulus payments for children MORE said it faces legal limitations to do so.

“It will be something we may need to return to Congress and get additional funding,” he told reporters on Tuesday.

The Ministry of Energy has also started leasing 23 million barrels of storage space from oil companies to pay for oil.

But experts say the only foolproof way to really start burning through excess supply is to reopen the economy to increase demand.

“The only thing that will really help is to get the application back online, which will require reopening the country and bringing people back into the cars,” said Braziel, a process that could take months.

Take advantage of the low prices, but understand the disadvantages

Low crude prices have of course filtered down to the pump. Gas was selling at an average price of around $ 1.80 a gallon this week and fell to $ 0.78 at a rural Minnesota service station earlier this month.

But while it may help consumers save by filling up, the disruption in oil markets is a symptom of larger economic problems.

More directly, it will result in gasoline tax losses and other revenue for cash-strapped state governments. This is especially bad news for the big oil-producing states that rely heavily on oil to finance their operations, such as North Dakota, Wyoming and New Mexico.

And lawmakers in oil-producing states have repeatedly warned of the economic impacts of losing jobs in the industry of 10 million workers.

“We face the real and current danger of hundreds, if not thousands, of oil producers yielding, an event that will have a profound and negative impact on the industry, its financial partners and consumers for years to come. The prospect of becoming dependent on oil imports is an unacceptable situation and we must do everything we can to avoid it, “wrote the legislator in a letter directed by Sen. Kevin CramerKevin John Cramer NIGHT ENERGY: Trump criticizes banks for withholding funds from certain fossil fuel projects | Treasury plans oil producer loan program | White House takes advantage of Arbor Day to renew campaign for the 1 trillion tree initiative GOP Senators: Tie WHO Funding to Cooperation with Congress Probe OVERNIGHT ENERGY: Trump Says national parks to start reopening | Oil prices begin to rise under pressure to finance a struggling industry | Al Gore approves Biden PLUS (R-N.D.).

Even the climate may not benefit from low oil prices, as it is more difficult for other technologies to remain cost competitive.

“If gas prices are low, there is concern that this will slow down the adoption of electric vehicles or other clean energy solutions,” said Tim Donaghy of GreenPeace at The Hill.



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