The spread of the novel coronavirus has ravaged the global energy industry. Even before the spectacular oil price crash that sent the West Texas Intermediate benchmark to nearly $40 below zero, the global demand for oil had plummeted as COVID-19 pressed the pause button on economies around the world.
Despite the desperate plunge in oil demand, however, a spat between Russia and Saudi Arabia pushed both countries to produce more oil in an oil-price war that has caused a historic global crude glut that has maxed out a vast amount of storage capacity and has oil sitting in tankers around the world as the glut continues to grow. If no one is buying oil and global storage is already edging toward maximum capacity with the potential to push the Brent international crude benchmark into negative pricing territory, why is oil still being produced at an alarming rate?
“The short answer is that production is decreasing — just not fast enough,” reported National Public Radio on April 22. “The crude markets move in slow motion,” said vice president of market intelligence for Enverus Bernadette Johnson in an interview with the public broadcasting company last week. “So what we’re seeing is almost a slow-motion train wreck.”
Part of the problem is that the infrastructure of the crude oil trade itself moves at a snail’s pace. “Crude in a pipeline can take weeks to reach its destination, which means oil purchased in mid-March could still be in transit in mid-April. This spring, the world completely transformed faster than some oil could finish that trip.”
Then there is the issue of oil producers, who are loath to reduce their production at a time when they sorely need cash. In fact, running a well at a loss, in many cases, can be the right economic decision for a company that’s thinking long-term. “As long as prices are greater than zero (an unusual disclaimer for these unusual times), a well will still bring in some money. And oil companies have fixed costs they have to cover. Even if they’re taking a loss overall, it may be better to keep a well running than to bring in no money,” reported NPR. Quite simply, many firms have yet to reach their shut-down price.
And many oil companies are holding out hope for the future. While it seems that the worst is almost certainly still to come for the oil industry, demand and prices are expected to bounce back eventually. Estimates for when and how much markets will recover are all over the board, but some optimistic analysts predict that the current shutdown of oil companies and production capacity will leave the shale industry stronger than ever and could actually push oil up to $100 a barrel.
Any hope for the future of oil prices rings eternal in the oil patch, where the economics often favor hanging tough through the economic downturn. “An oil well is not like a light switch you can flick on and off,” reported NPR. “A well that has been shut down can be hard to turn back on.” What’s more, if an active well is shut down and then a firm decides to get it up and running again, “it is almost guaranteed you will have to invest more money in the well to get it to produce at the same level,” Elizabeth Gerbel, CEO of oil and gas consulting firm EAG Services, was quoted by NPR. And then there are legal contracts to consider, on top of all the other complications of shutting in a well.
Despite this fact, plenty of producers have begun to shut down production as the price of oil plummets, and many more are likely to meet their shut-down price in the near future if markets continue to be as dismal as they have been in the past months. And that is seeming very likely.
By Haley Zaremba for Oilprice.com