The Oil Apocalypse Sets the Stage for Expensive Oil In the Future
On Monday, May crude WTI oil NYMEX futures that expired today evaporated to a negative $37 per barrel (bbl) as traders, producers, refiners, hedge fund speculators, anyone with long positions scrambled to avoid the burden of physical delivery of this overabundant commodity. There's just no place to put it. Players race to exit the burning theater through a narrow door. Light volume of 150 thousand contracts for May versus over 1.1 million for the new front-month June, exacerbated price action. Positions were either closed with painful cash losses or most probably rolled to the June contract. The price dropped $30 or more in the final 10 to 15 minutes of trading, indicating a frozen market where there was no bid; buyers had left the building. June closed down over fifteen percent near $20 bbl. Since the 1983 introduction of the NYMEX crude futures contract, until Monday, it had never seen negative territory.
Tuesday morning, the May WTI contract sits at a dollar and change (up over $38), while June sagged 25 percent to around $15 bbl. This afternoon, May and June's prices weirdly converged around $10, meaning the June contract collapsed over 50 percent. July and August trade around $15 and $22 bbl, so the contango says expectations are demand will improve. Contango remains a perception only. As things stand now with this unprecedented price action, a repetition of yesterday's category five market storm stands as a probability.
The claim is the world has an oversupply of 30-35 million bbl/d. Russia and Saudi Arabia and OPEC cohorts, after the usual internal acrimony generously agreed to a temporary 9.7 million bbl/d production curtailment. The U.S., Canada, and Brazil, in theory, will kick in another 3.7 million bbl/d through natural declines due to low oil prices. And the rest of the G-20 supposedly will reduce their supplies by 1.3 million bbl/d. No matter how you place these numbers in the calculator, the results are dismal.
The Texas Railroad Commission, overseer of all things oil, now undergoes pressure from producers like Pioneer Energy that want to implement production quotas; As if removing a few hundred thousand or million barrels a day from the Permian, can somehow rebalance a market 30 to 35 million bbl/d oversupplied.
For a couple of weeks, headlines have warned of waning storage capacity. Cushing, Oklahoma, the central storage hub for West Texas Intermediate (WTI) crude oil, handles an estimated working maximum of 76 million barrels. The above mentioned NYMEX futures contract is the derivative based on Cushing specifications to qualify as WTI. The latest data from April 10 already outdated, put current inventories at 55 million barrels, but space is renting so quickly, experts prognosticate Cushing tanks will be chock-full by the second week of May at the latest. Then what?
According to the EIA, the U.S. crude oil storage capacity, exclusive of the Strategic Petroleum Reserve, stands at 521 million barrels. Fifty-five percent of that sits on the Gulf Coast, primarily from Corpus Christi east to New Orleans, with the bulk of the tank farms being from the Houston Ship Channel to the Beaumont-Port Arthur area. We can describe this seventy-five-mile swath as the refining capital of the world. (In counting storage, Cushing is not part of the Gulf Coast.)
An Ugly Chain of Events:
Hypothesis on when the Gulf Coast tank farms will overflow change daily. Let's assume it takes until the end of May for this D-day. By this time, any floating storage will be a long time unavailable. The ultimate buyers, the refiners, run at 65-70 percent of capacity. Gasoline demand is low, and there is almost no need for jet fuel. Only diesel, because of trucking and some manufacturing, has buyers. So, the flow of product through the pipelines of Enterprise Products, KinderMorgan, and Plains All American, slows to a trickle. The producers in Eagleford and Permian and the Bakken will have no choice but to curtail production and shut-in wells.
Now consider the contract ramifications between the myriads of parties. The producer probably has a clause in his lease that might say that any more than three months inactivity and the producer goes into default. That producer has a two-year contract to sell 10,000 barrels a day directly to the refiner in Beaumont. The refiner wants to renege for a lack of adequate demand. But the producer has a take or pay contract with the pipeline. He has guaranteed a 10,000 bbl/d flow, whether or not he takes the capacity. With moribund drilling activity, the service industry has been put on a ventilator. The pipeline majors (EPD, KMI, PAA) undoubtedly have multi-year contracts with giant producers like Chevron or Exxon, which are also in the storage and refining business. Whether or not their leases force them to keep pumping oil, when their storage fills up, and their refiners can't sell their end product, they will renegotiate their take or pay contract with the pipeline. In short order, midstream companies will end up shipping less oil at lower prices. Cash flows get hammered, so none of their generous dividends are safe.
The storage owners have raised their rental rates, and oil tanker rates have doubled. Some are always positioned to swim well in the turbulence.
What about the billions banks and private equity have lent to the E & P sector? Amidst the euphoria of years of cheap money, lender and borrower alike failed to reminisce about the glorious days of 2008-9. Darwin's rules say many of these leveraged unfortunates must not live to fight another day. Some producers do have hedges, mostly swaps or collars, which temporarily can protect their balance sheets from low prices. Still, with any derivative, your contract is only as strong as your counterparty.
At some juncture, does the edifice become so waterlogged it freezes? Pipelines cease to operate, and drillers pay to have oil hauled away and dumped in lakes, rivers, open pits? The banks foreclose on tens of thousands of wells, and only a handful of players survive.
This bleak worldview forces everyone to tear up contracts and start over. Otherwise, on this course, our oil industry implodes per the dreams of our good friends, the Russians, and the Saudis. Surely a coincidence, exacerbating current woes are 20 Saudi VLCC's each transporting 2 million barrels, which at least 80 percent, aimed at the Texas and Louisiana coasts. In the face of Saudi denials, I spoke to an expert that identified the names of most of the ships and tracked their locations. Several already sit parked just off the Texas coastline. These barrels represent seven times Saudi average Gulf Coast import volumes. Presumably, most of this oil is already spoken for. But in the meantime, as it makes its way through the system to the refineries, it will occupy critical storage space ordinarily for American oil. Why now, this sudden Middle East rush unless to force our country into an even more submissive position. The political outcry, which I support, calls to deny these ships' rights to offload their cargo.
Market forces remain so out of whack, U.S. production could go to zero (from 13.3 million bbl/d at the start of 2020) without putting laws of supply and demand in balance. Other major world producers, Saudi Arabia, Russia, Iran, Iraq, the Emirates, Venezuela, and Mexico, all stand as countries where petroleum is state-owned. Revenue from the black gold makes up a massive percentage of national budgets. Though captive to the vicissitudes of prices, countries share no risk of the capitalist model of competition, and hence survival. All of these countries now run enormous deficits to continue to fund all the social programs that keep their restive populations from rebellion. Would these nations deplete all cash reserves in their efforts to bring America to heal? If they win, would it be a pyrrhic victory?
President Trump promises to "save" the oil and gas industry. Trump offers something impossible. The business stretches into every crevice of our economy, transport to technology, and still powers almost everything from Amazon warehouses to Greenpeace U.S. headquarters. If the oil industrial complex fails, America will walk in tandem. Despite all their hype, wind and solar generate, less than three percent of combined U.S. energy consumption.
We have the answer without the will. Political correctness forbids our country from going back to work and creating hydrocarbon demand. More will die from the fallout from health and social problems of 50 million jobs destroyed than could ever be lost to COVD-19.
Experience and Newton teach that for every action, there is an equal and opposite reaction. Zero dollar oil will beget the wasteland to the next supply shortage and return of a hundred dollars a barrel.
