The Beginning of the End for Oil: Lower Oil Prices Here to Stay
Whatever hopes there were for a rebound in oil prices overnight, they were quickly dashed.
After prices for crude oil went negative yesterday (-US$37.63), markets were hoping for a reprieve. Indeed, some wrote off this unprecedented turn of events as simply a short-term anomaly.
I doubt anyone ever expected people would pay customers to take their oil. A bizarre situation that reflects just how mismatched supply and demand for oil is right now.
Overnight though, markets showed us it’s here to stay.
The price of June futures contracts for oil fell 43.37% last night. Sliding from US$20 per barrel down to US$11.57 per barrel.
What that tells us is that lower oil prices are here to stay. The supply and demand gap isn’t shrinking.
It makes perfect sense when you think about it.
Across the world almost every economy has come to a halt in some capacity. Though the big factor for all will be less movement of people in general.
Grounded airlines, fewer people driving to work, and falling trade are just some of the reasons demand is drying up. So, typically the response from suppliers would be to stop producing more oil.
Trouble is, supply cuts have happened and are still happening. But even with these cuts, the price keeps falling. Again, highlighting just how far demand has slumped.
Which begs the question, what the hell happens next?
A sinking ship
The reality is, the US’ oil industry will be lucky to survive this downturn. I’m sure some of the bigger and better funded players will endure, but they will be the exception.
One shale analyst is even quoted as saying:
‘At $10, almost every US E&P [oil exploration & production] company that has debt will have to file Chapter 11 or consider strategic opportunities.’
In other words, find some way out or face bankruptcy. At least that’s what should happen…
As the US oil industry faces its crisis, Trump is already preparing to swoop in and save the day. Categorically stating:
‘We will never let the great U.S. Oil & Gas industry down.’
In other words, expect to see a fresh round of bailouts if things don’t improve. A response that could take us even further down the rabbit hole than we already are.
See, bailouts are a dangerous road to travel down. It can distort entire sectors and exacerbate inefficiencies rather than resolve them. Take this argument from OilPrice for instance:
‘Smaller independent producers tend to support some kind of coordinated action to restrict supply, arguing that the free market will wipe out the smaller players in the industry.’
In other words, these smaller players want an OPEC-like situation. Intervention that distorts the free market to ensure they survive.
I don’t know about you, but I can only see this doing more harm than good.
Free markets are the backbone of a strong economy. Meddling with them often leads to bigger and stranger problems.
We even have a name for such an outcome: the law of unintended consequences.
The end of oil
Remember in the 2000s when everyone was freaking out about ‘peak oil’? The idea that the world was going to run out of this crucial commodity.
It was quite the compelling narrative for a while there. That is until the US discovered shale. A boom that left the peak oil argument all but dead and buried.
But, that doesn’t mean oil can’t come to an end in other ways. The founder of Bloomberg’s New Energy Finance, Michael Liebreich, has stood by a different narrative, as he tweeted on 9 March:
‘I’ve always said the end-game for oil is not when it reaches $200/barrel, it’s when it settles at $20/barrel. Looks like we may be about to see our first run at $20 in the coming months. After coronavirus, expect a volatile decade, followed by structurally low prices from 2030.’
Right now, Liebreich has to be feeling pretty smug given what we’ve seen in the past two days. But whether he will be right in the long run remains to be seen.
His point though — that oversupply not over demand will be the end of oil – is a key one. Whether we’ve reached that inflection point just yet, I don’t know.
If the US ploughs ahead with a bailout of the local industry though, I could believe it. Propping up the sector will only ensure oil prices remain lower for longer in my view. And as we’ve already seen, that will have a far-reaching effect on all sorts of markets.
Indeed, it’s yet another sign of the impending ‘Zero Hour’ my colleague Shae Russell has been talking about recently. An event that will turn financial markets on their head — and not in a good way. But, there is one sector that could thrive according to Shae’s theory: gold.
My take is slightly more optimistic though. Whether this is the beginning of the end for oil or not, it doesn’t really matter. Energy markets will find new avenues.
I mean even the US Department of Energy knows that. For example, they published a report detailing the potential of thermal energy just last year. A resource that is vast but untapped.
Until recently though, the challenge for thermal has been the costs. The technology and infrastructure is still expensive. Now though, with the price of oil falling, that might be about to change.
Up to 50% of the costs associated with thermal energy can be linked to oil. A key resource that is used to facilitate the drilling of sites. So this downturn for oil, whether it is here to stay or not, could provide the perfect opportunity for alternative energy sources, like thermal, to thrive.
And ultimately that is the key point. One way or another markets will find a way forward. Hopefully with as little tampering as possible.
Editor, Money Morning
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