Oil was already hurtling towards its worst quarter on record, but things got markedly worse on Monday, when futures in London cratered more than 9% and WTI fell as low as $19.92. Irrespective of how things pan out over Monday and Tuesday, this was a game-changing quarter for crude.
On Sunday, I spent a considerable amount of time discussing the unprecedented demand destruction associated with the draconian travel restrictions and lockdowns implemented globally to stop the spread of coronavirus.
Long story short, it isn’t the best time to be a petrostate, and yet Riyadh and Moscow remain at loggerheads three weeks into a bruising price war which kicked off following an acrimonious OPEC+ meeting in Vienna.
Read more: The Great Petrostate Panic.
The declines in crude precipitated by this perfect storm (an epic demand shock and a simultaneous supply shock) are breathtaking.
Prices are poised to fall the most for any quarter on record and volatility is (literally) off the charts. Those are hardly the only statistics you can conjure. Pretty much any chart associated with the market is now an eye-popper.
One persistent theme in 2019 was that geopolitical turmoil (particularly the escalations in the Strait of Hormuz with Iran and the September attacks on Abqaiq and Khurais likely directed by the now deceased Qassem Soleimani) and other supply disruptions were insufficient to overwhelm lingering demand concerns tied to, among other things, the trade war.
Well, as it turns out, the market hadn’t seen anything yet when it came to demand destruction.
In a new note, Goldman’s Jeff Currie lays out a sweeping vision for the future of the energy industry, most of which is well beyond the scope of any one article or post.
But the opening paragraphs are chock-full of quotables and figures that underscore just how dramatic this last month has been for the market.
“With social distancing measures now impacting 92% of global GDP, the ultimate magnitude of these shut-ins which is still unknown will likely permanently alter the energy industry and its geopolitics, restrict demand as economic activity normalizes and shift the debate around climate change”, Currie writes, on the way to declaring that “not only is this the largest economic shock of our lifetimes, but carbon-based industries like oil sit in the cross-hairs as they have historically served as the cornerstone of social interactions and globalization, the prevention of which are the main defense against the virus”.
He then says the hit to oil demand is probably twice that to economic activity more generally, with “demand this week down an estimated 26 million b/d”.
That, folks, would represent a roughly 25% plunge in demand, which averaged a bit over 100 million barrels a day in 2019.
“This shock is extremely negative for oil prices and is sending landlocked crude prices into negative territory”, Currie goes on to say, adding that although the world likely has somewhere in the neighborhood of a billion barrels of spare storage capacity, “much of that will never be accessed as the velocity of the current shock will breach crude transportation networks first”.
Considering the cost of shutting a well down, producers would rather just pay somebody to get rid of a barrel, Currie says. That, in turn, equates to negative prices in landlocked locales.
He uses that to make an important, if intuitive, point – namely that “shut-ins will be not be based upon where wells sit on the cost curve but rather on logistics and access”. So, if you’re landlocked, the market may well go negative. On the other hand, “Brent is likely to stay near cash costs of $20/bbl”, Currie remarks.
As noted Sunday, analysts and market watchers expect oil demand to shrink dramatically for the full year 2020. As of midway through March, IHS Markit predicted a contraction of 1.42 million barrels per day on average for the year, while oil consultants project a similar-sized drop.
In the second quarter — a period when the global economy will be hit the hardest by coronavirus containment measures — some see demand collapsing by between 4 and 10 million barrels a day. Those short-term drops would dwarf the full-year contractions seen in the early 80s.
It’s through that lens that you should view Goldman’s estimate of a 26 million b/d demand collapse this week.
Beyond the above, Goldman’s Currie (along with Damien Courvalin) delves into a pretty trenchant discussion of what the future holds for the energy industry and for humanity more generally. Here’s a quote that gives you some flavor: “Technological hysteresis is already occurring. People are adapting to a more local existence and living off more sustainable activities, consuming less globally-produced fresh food, producing less waste with a more conservative approach to consumption, all of which may have lasting impacts on demand.”
As interesting as that discussion most assuredly is, it’s well beyond the scope of anything I’ll endeavor to cover in a single piece. Instead, I’ll leave you with three very short additional quotables from Goldman, each one of which makes a critical point. To wit:
- During 2008 and also in this crisis, dollar funding and credit constraints that prevent oil owners from accessing storage and transportation capacity also played a role. We believe that the Fed’s actions last week alleviate some of this risk, but oil itself creates dollar liquidity given its importance in global trade and setting the price of other traded goods and another sharp drop in oil prices could create additional dollar shortages.
- The oil price war is made irrelevant by the large decline in demand and has made a coordinated supply response impossible to achieve in time.
- We believe the current oil crisis will see the energy industry finally achieve the restructuring it so badly needs. We have long argued that it is the supply and demand of capital that matters, not the supply and demand of barrels; as long as there is capital, companies can withstand difficult periods and the barrels always come back.