Oil’s Collapse is Continuing
Melbourne’s weather is crazy. But coming from southern Spain, it really took me by surprise.
You could be walking around Melbourne in your summer clothes when, suddenly, you feel something’s changed. The wind picks up, the clouds come in, and the temperature drops quickly.
Now you feel cold, and it’s starting to rain.
That’s when you run for cover.
As I found out today, that phenomenon even has a name: southerly buster.
The global economy is certainly getting that change of wind feel.
The latest is coming from the oil market.
Oil prices collapsed falling into negative territory yesterday.
How can they be paying to take oil when it costs money to bring it up from the ground? Yep, I hear you. But here we are.
Oil’s collapse is continuing today.
Bloomberg reports this morning:
‘Oil’s collapse is deepening.
‘Just a day after U.S. crude futures for May delivery plunged below zero for the first time ever, June futures plummeted 43% to close below $12 a barrel in New York. A massive supply glut brought on by the pandemic and a worldwide shortage of storage space have touched off a relentless rout that has shifted the entire forward curve for oil.
‘The meltdown spreading across global oil markets has already wiped out tens of thousands of jobs and frozen billions of dollars in capital spending.’
Oil has two huge problems
Oil futures are oil that is set to be delivered or settled in the future. Traders usually buy them to profit from fluctuations in oil prices. The price dropping to negative yesterday shows how desperate people were to get rid of these contracts before they expired.
While you may have heard a lot about electric cars and renewable energies, oil is still quite crucial for our global economy. It fuels all sorts of transports: planes, cars, boats…
Now oil has two huge problems: Demand and supply.
With the world in lockdown, we are driving less, travelling less, and there is less trade. In short, demand for oil has collapsed.
This comes at a time when there is a lot of supply in the market.
Over the years, you may have heard a lot of fear about ‘peak oil’ and what it could mean to our global economy. Peak oil refers to the notion that oil production at some point would peak and supply would dry out, making prices go higher.
But that hasn’t happened. Instead, the US came out with shale oil, which was a huge game changer.
Fracking has meant that in the last decade, the US has been decreasing their oil imports and increasing exports to the point that they have become one of the largest oil exporters in the world.
All that influx of US shale has kept oil prices down.
At the beginning of March this year though, oil prices collapsed when Russia and Saudi Arabia couldn’t agree on production cuts.
It may all have been a ploy to end US shale oil. It’s something that Saudi Arabia tried before in 2014…and failed miserably at.
Back then, the Saudis tried to bankrupt US shale oil drillers by pumping more oil to lower prices. Since it’s more expensive to drill shale oil, they hoped that the lower prices would send drillers out of business.
Yet US shale drillers managed to push production costs lower and instead the Saudis took quite a hit on their cash flow. By 2016, Saudi Arabia agreed to limit production to push prices up.
10 days ago, oil producers agreed to a cut of 9.7 million barrels per day — or 10% of global oil supply — to counter the effects of COVID-19, effective next month.
But, is that enough in a world where demand has completely collapsed? Probably not.
The shale revolution is also not all that it’s cracked up to be.
Shale drillers aren’t generating enough cash and production declines overtime. Coincidentally, shale oil took off with low interest rates, which means that they have been able to survive by taking on more debt.
What’s interesting is that oil played quite a part the last time the system shuffled.
In the 1970s the Bretton Woods system collapsed when US President Richard Nixon cut the link between the US dollar and gold to prevent a gold run. It turned the US dollar into fiat currency, that is, it’s not backed by anything.
Soon after, Saudi Arabia and the US reached an agreement and along came the petrodollars.
In exchange for US military aid and protection, Saudi Arabia would price oil barrels in US dollars. It made the US dollar the world’s reserve currency.
At the same time, US dollars get somewhat ‘recycled’ as Saudi Arabia spends their petrodollars in Treasury bonds to finance US expenses. It creates liquidity as those dollars end up coming back into the US financial system.
Low oil prices are already impacting US shale oil. So far, the US has vowed to support their shale oil industry.
The Australian reports today:
‘Monday’s price moves make it more likely that President Trump will impose tariffs on oil imports into the US, added Mr McNally, a former White House adviser.
‘Mr. Trump in a tweet Tuesday said he had directed the Energy and Treasury departments to craft a plan to make funds available for the oil-and-gas industry. “We will never let the great U.S. Oil & Gas Industry down,” he wrote.’
Trump has also said he would consider blocking Saudi Arabian imports of crude oil.
But things could turn ugly, which could bring some implications for their 1970s agreement.
The wind is certainly changing…and it’s doing so very fast. The world could look a whole lot different once COVID-19 lockdowns end.
Our editor Shae Russell has some ideas to help you prepare. Learn more about that here.