As major economies go into lockdown, oil demand continues to fall off a cliff. On Monday, WTI fell into the $20s.
“The additional quarantine measures imposed in France, Spain and elsewhere over the weekend has spurred a ‘world championship’ in demand loss forecasting this morning,” Bjoernar Tonhaugen, Rystad Energy’s head of Oil Markets, said in a statement.
A week ago, the U.S. was doing very little. In just a few days’ time, there has been a proliferation of school cancellations, mass gathering prohibitions and mandatory telework orders. Restaurant closures are next. Pretty soon much of the country will be on some form of a lockdown.
The Federal Reserve slashed rates to near zero over the weekend, using up all of its ammo to head off as economic recession and financial crisis. The central bank also said that it would purchase “at least $500 billion” in Treasury securities and “at least $200 billion” in mortgage-backed securities.
It’s not clear that it will be enough. Congress will be under pressure to pass bailout legislation in the coming days and weeks.
Loose credit will do very little to stoke demand when tens of millions of people go into lockdown. Airlines are on track to cut flights by 75 percent for April and May. Pierre Andurand, who runs oil hedge fund Andurand Capital Management, said that oil demand could fall by 10 million barrels per day (mb/d) for a period of time, a contraction with no historical precedent. Oil trading giant Trafigura agreed on the 10-mb/d demand destruction estimate, and said demand could yet drop further. Related: The Great U.S. Shale Decline Has Already Begun
Several analysts say that oil prices will likely continue to fall. “The potential loss of demand in March-April may dwarf anything the World has ever seen, just when OPEC+ producers open the floodgates of new supply to the market,” Bjoernar Tonhaugen of Rystad Energy said. “The price of oil may in the coming months need to drop down to short-run marginal cost of production in order to incentivize forced shut-downs of production globally.”
Rystad’s data suggests that only 16 shale companies have average new well costs at less than $35 per barrel, as Reuters points out. And that does not take into account debt servicing, dividends, and the array of other corporate costs – it only accounts for preparing and drilling a new well. Needless to say, if U.S. shale was struggling at $50, drilling at sub-$30 makes sense for no one.
Analysts at Goldman Sachs echoed the conclusion that oil could fall further, forcing an immediate halt to drilling. “[T]here is high risk oil prices move to cash costs or breach traditional floors temporarily of average cash costs for US/Canadian oil producers ($23/$26 per bbl WTI,” the investment bank wrote in a note on Monday. “We do not believe we are at bottom.”
Goldman said total capex from the U.S. shale industry could fall by 30 percent and that U.S. oil production could fall by 1 million barrels per day between the 2Q2020 and 3Q2021.
That could be underestimating the impact. IHS Markit said the supply hit to U.S. shale could be more like 2 to 4 mb/d over the next 18 months. Related: Largest Oil Glut In History Could Force Crude Prices Even Lower
President Trump tried to throw a lifeline to oil prices last week when he announced that the Department of Energy would buy up oil for the Strategic Petroleum Reserve (SPR) and “fill it right to the top.”
Oil prices rose on Friday but were down sharply on Monday, more than erasing the price bump from the announcement. In the grand scheme of things, the SPR purchases pale in comparison to the hole in the market. The “peak pace of SPR injection of 0.5 million bpd remains short of the current surplus of 6 million bpd,” Goldman Sachs said.
It’s also not clear if the SPR plan will pass in the U.S. Congress. Even if DOE moves money around to complete the purchases, the plan is a sideshow compared to the broader problems at hand for the industry.
“There are no good answers for the industry in a $30 per barrel environment,” Stephen Richardson, a shale analyst at Evercore ISI, wrote in a report last week.
By Nick Cunningham of Oilprice.com
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