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With government institutions enforcing a shutdown due to the COVID-19 outbreak, the demand in the oil market has plunged to a record low. Countries like Saudi Arabia and Russia have ramped up production amidst weakening demand.
The coronavirus pandemic has put the global logistics and travel on a standstill. Besides, there’s no certainty as to when things will resume to normal. Earlier this month, the OPEC and its non-OPEC allies failed to reach an agreement on the oil production owing to the weakening demand. This triggered an oil war between the two camps with Saudi Arabia opening its taps.
The crude price has come crashing down since then. At press time, Brent crude is trading at a price of $27 per barrel. Some analysts are saying that if the situation continues to persist, we can see oil prices going below $10 per barrel and in some cases even negative.
With the rising COVID-19 cases all around the world, governments have initiated some unprecedented decisions of shutdown to prevent the spread. Well, this has given a major shock to the energy sector, especially the oil market with demand falling drastically. Goldman Sachs analysts warn that:
“The coronavirus shock is extremely negative for oil prices and is sending landlocked crude prices into negative territory.”
Fears of Negative Oil Prices
Analysts have also warned that the storage capacity can reach its maximum within weeks. On Wednesday, the three-year pact between OPEC and non-OPEC allies ended on curbing the oil production. Saudi Arabia has already announced that it would be hiking the output to a record high.
Now with the global consumption already drying up, the world will reach its maximum storage capacity sooner than expected. This means that post the full capacity, oil prices can actually turn negative. Meaning, oil-producing companies will actually pay consumers to take oil from the. Bjarne Schieldrop, the chief commodities analyst at SEB, told CNBC:
“Refineries in many places are now losing money for every barrel they process, or they have no place to store their output of oil products. For land-based or land-locked oil producers, this means only one thing. The local oil price or well-head price they receive very quickly goes to zero or even negative, because if they have too much oil, they must pay someone to transport it away until they have managed to shut down their production.”
A Eurasia Group analyst said:
“Industry participants are saying it is virtually impossible to find conventional onshore tanks. Even if OPEC and other producers start restricting their output again soon, the supply overhang from the global lockdown is so big that storage capacity will likely hit its limit by midyear. Already, ports and refiners are turning away oil tankers. This will put even more downward pressure on prices and pose an existential threat to many companies.”
Russia’s Export Urals Oil Price Turned Negative
As per Argus Media, the price formula for Russian Urals oil has turned negative this week. Note that this pricing formula is the benchmark for pricing in the domestic market. The problems are obvious not only with Urals oil. On Monday, the oil price in Western Serbia turned to minus 1007 while that on Tuesday was minus 1200.
Analysts are expecting that the ongoing price war between Russia and Saudi Arabia will keep production elevated by the end of the year. This will have an overall ripple effect on the industry. Some of the strongest oil producing companies in the U.S. said that they plan to cut back spending and production. Last week, Chevron announced that it will cut its spending by 30%. Goldman Sachs predicts that the industry will lose nearly 5 million barrels per day of oil capacity.
Now, suppose that the COVID-19 situation comes under control in a few months and industries start their operations. Goldman Sachs commodities head Jeffrey Currie says that this will create a sudden oil demand in the market. However, by that time, the oil wells would be shut down and won’t be producing as much oil as required. This can suddenly turn in an oil scarcity shooting up the prices. “This will ultimately create an inflationary oil supply shock of historic proportions,” Currie wrote.