Oil Prices Fall Below Zero

Oil prices fell below zero on Monday for the first time in at least 155 years, dragging major stock indexes down, as well. West Texas Intermediate crude oil prices fell to -$37.63 per barrel during trading on Monday, and the S&P 500® index closed down 1.8%.

COVID-19-related business closures and stay-at-home orders around the globe have sharply reduced demand for oil, and U.S. oil producers can’t cap their oil wells quickly enough to reduce supply to match lower demand. Oil storage facilities around the country are nearing full capacity, so producers are having pay to get rid of their oil.

While there were complications surrounding the expiration of the May crude oil futures contract, the cash market was the main source of the volatility. Oil scheduled to be delivered in June also fell, sliding 16% to about $21 a barrel.

The U.S. Energy Information Administration (EIA) has forecast global oil demand to fall by more than 23 million barrels per day in the second quarter of 2020, or about 23%. But implied demand in the U.S. has dropped even faster, with refineries cutting back liquid fuel production by more than 40%, according to the April 10th EIA report.

 In the U.S. oil market, major oil companies plan big production cuts, net oil imports continue to fall sharply, and new drilling is coming to a halt. However, it will take some time to implement production cuts, and U.S. oil storage capacity is quickly being filled by the excess supply. U.S. storage tanks will be full in less than two months if the pace of inventory increase continues, according to the EIA.

Saudi Arabia recently made a deal with 23 oil-producing countries to cut production by nearly 10 million barrels per day. However, even that will still be well short of what will be needed to balance the global oil market.

What should investors do? 

The price of oil will continue to experience heightened volatility until supply and demand can be balanced. While oil companies are dealing with significant short-term inventory issue, energy company stocks are heavily influenced by the future price of oil—that is, one to two years out. Those prices are still positive, which helps explain why energy company stock prices did not fall by as much as one might have expected today.

Still, with oil prices well below profitable levels, the impact of COVID-19 on energy companies is expected to be enormous, particularly for smaller exploration & production and oil services companies. In a recent Kansas City Federal Reserve Bank survey, nearly 40% of oil companies said they would be insolvent within a year if oil prices were to stay at or below $30 per barrel.1 Larger oil companies—while still likely to see sharp financial losses—are in relatively better shape. The biggest companies have greater ability to make cost cuts, as well as access to credit lines, which can limit insolvency risk.

 

1 Federal Reserve Bank of Kansas City, First Quarter Energy Survey, “Tenth District Energy Activity Decreased as a Steep Pace,” April 7, 2020.

About the author

Photo: David Kastner

David Kastner

CFA®, Managing Director – Senior Investment Strategist – Charles Schwab Investment Advisory