WTI Index Crash & The Russo-American Markets
By Riya Mathur and Derrick Cui, 6/24/2020
WTI & American Oil
In mid-April, benchmark West Texas Intermediate (WTI) futures crashed into negative territory for the first time in its history. Brought by a price war between Saudi Arabia and Russia, and falling demand from COVID-19, the world wondered what this meant for the future of oil. Prices quickly rebounded to $42 a barrel of Brent crude as OPEC (Organisation of the Petroleum Exporting Countries) cut production by a record 9.7m barrels a day in May and June and extended it by another month.
This begs the question: did the WTI crash create its own issues or accelerate trends? Arguably, it has done both.
What demand trends existed before this shock? According to an Oil and Gas forecast by DNV-GL in 2017 (international accredited classification society), as costs of sustainable energies fall, consumption of non-renewables will fall, with hydrocarbons only accounting for only 44% of the total worldwide energy mix by 2050. Oil demand is expected to peak by around 2025. Though this peak had not been reached yet, investors have been worried. On top of that, climate activists, rising consumer demands, and tightening regulations (in Europe at least) have prompted investors, like BlackRock (world's largest asset manager) to slash investments in non-renewables. In fact, the International Energy Agency (IEA), an intergovernmental forecaster, estimates that upstream investment this year will fall to its lowest since 2005 after increasing for over a decade, at around 0.3 trillion in 2020 from its peak at 0.9 trillion in 2014. So far, slowing demand and falling renewable prices (accelerated by increased renewables investment) have decreased private US oil investment and caused investors to question the profitability of oil.
This directly ties into supply. Unlike other countries, US oil production is driven by private investment. As oil reserves are continuously depleted, investment is needed to find new oil reserves, frack them, and develop supply routes. Variable prices (like a crash in prices from 2014 to 2016) have recently discouraged investors to back large, high-risk projects. U.S. oil companies, however, have been bracing for a decline in oil prices for some time, tightening their budgets and receiving more value-per-barrel. The deregulation of environmental restrictions by the Trump administration and rising prices may have prolonged oil’s lifeline in at least the US. Perhaps, if the negative oil crash never happened, through long-term planning, oil companies could have prolonged their existence and shifted their energy production.
However, negative oil prices did cause a shock that was unexpected, which was followed by mass cuts to production, small oil firms going bust, and large firms pilling more debt. Rystad Energy, a data firm, estimated that of the 3 million barrels a day cut in production in the US and Canada in May, 10-15% will never restart. Though COVID-19 relief has allowed oil companies to receive aid, many are crumbling under their debt and can no longer cut costs. With falling investment interest in US oil, it is only a matter of time before US firms merge, go bankrupt, or shift energy production. This cycle of high prices, investment, and supply is breaking.
Though oil production will most likely ramp up over the second half of 2020, investors are jumping ship from oil investment. At the same time, the world’s appetite for oil is falling. This bodes well for OPEC countries minus-US that have lower break-even prices or have state-owned oil companies which can be supported by the government. These countries can, in the future, control more of the oil profit as investment limits US oil production. Negative oil prices have accelerated trends and acted as a wake-up call to investors; oil is risky in the US, is not as profitable as once thought, and the US will not lead dwindling oil production in the future.
This begs the question: did the WTI crash create its own issues or accelerate trends? Arguably, it has done both.
What demand trends existed before this shock? According to an Oil and Gas forecast by DNV-GL in 2017 (international accredited classification society), as costs of sustainable energies fall, consumption of non-renewables will fall, with hydrocarbons only accounting for only 44% of the total worldwide energy mix by 2050. Oil demand is expected to peak by around 2025. Though this peak had not been reached yet, investors have been worried. On top of that, climate activists, rising consumer demands, and tightening regulations (in Europe at least) have prompted investors, like BlackRock (world's largest asset manager) to slash investments in non-renewables. In fact, the International Energy Agency (IEA), an intergovernmental forecaster, estimates that upstream investment this year will fall to its lowest since 2005 after increasing for over a decade, at around 0.3 trillion in 2020 from its peak at 0.9 trillion in 2014. So far, slowing demand and falling renewable prices (accelerated by increased renewables investment) have decreased private US oil investment and caused investors to question the profitability of oil.
This directly ties into supply. Unlike other countries, US oil production is driven by private investment. As oil reserves are continuously depleted, investment is needed to find new oil reserves, frack them, and develop supply routes. Variable prices (like a crash in prices from 2014 to 2016) have recently discouraged investors to back large, high-risk projects. U.S. oil companies, however, have been bracing for a decline in oil prices for some time, tightening their budgets and receiving more value-per-barrel. The deregulation of environmental restrictions by the Trump administration and rising prices may have prolonged oil’s lifeline in at least the US. Perhaps, if the negative oil crash never happened, through long-term planning, oil companies could have prolonged their existence and shifted their energy production.
However, negative oil prices did cause a shock that was unexpected, which was followed by mass cuts to production, small oil firms going bust, and large firms pilling more debt. Rystad Energy, a data firm, estimated that of the 3 million barrels a day cut in production in the US and Canada in May, 10-15% will never restart. Though COVID-19 relief has allowed oil companies to receive aid, many are crumbling under their debt and can no longer cut costs. With falling investment interest in US oil, it is only a matter of time before US firms merge, go bankrupt, or shift energy production. This cycle of high prices, investment, and supply is breaking.
Though oil production will most likely ramp up over the second half of 2020, investors are jumping ship from oil investment. At the same time, the world’s appetite for oil is falling. This bodes well for OPEC countries minus-US that have lower break-even prices or have state-owned oil companies which can be supported by the government. These countries can, in the future, control more of the oil profit as investment limits US oil production. Negative oil prices have accelerated trends and acted as a wake-up call to investors; oil is risky in the US, is not as profitable as once thought, and the US will not lead dwindling oil production in the future.
Russian Oil & The Brent Index
In addition to the Coronavirus pandemic, the world was put to the test yet again on April 20, 2020. ‘Black Monday’ saw the sudden plunge in the price of West Texas Intermediate (WTI) oil grade, turning negative for the first time in history to a steep -$37.63 per barrel. While the WTI mostly impacts the United States, being one of the most prominent crude oil indexes there are, such an unprecedented event was bound to have impacted other crude oil prices such as the popular Brent index, used in most of the world’s major countries including Russia, India and Europe. The price of Brent fell sharply too, by $10 shortly after the collapse of the WTI, although it did not go negative.
It would not be an exaggeration to point out a mixture of major cross country issues led up to this unprecedented event. The price war between Saudi Arabia and Russia began pushing prices down long before the Coronavirus became a full blown pandemic after Russia refused a proposal to cut down production drastically by a total of 3.2 million barrels per day. Market demands started falling, economic growth slowed down and commitments made by the OPEC countries stood on shaky grounds. “Be prepared for another drop in oil prices soon, when market participants realize that the real issue they have to deal with is the declining demand, for which the proposed cuts, even if realized, are set to fail to bridge the gap,” said Bjornar Tonhaugen, head of oil markets at Rystad Energy.
Consider Russia, the leader of non-OPEC countries, which relies on oil sales for a majority part of its earnings and as much as 40% of its total revenue. According to estimates, the Russian economy can decline by as much as 6% due to oil price shocks.
It would not be an exaggeration to point out a mixture of major cross country issues led up to this unprecedented event. The price war between Saudi Arabia and Russia began pushing prices down long before the Coronavirus became a full blown pandemic after Russia refused a proposal to cut down production drastically by a total of 3.2 million barrels per day. Market demands started falling, economic growth slowed down and commitments made by the OPEC countries stood on shaky grounds. “Be prepared for another drop in oil prices soon, when market participants realize that the real issue they have to deal with is the declining demand, for which the proposed cuts, even if realized, are set to fail to bridge the gap,” said Bjornar Tonhaugen, head of oil markets at Rystad Energy.
Consider Russia, the leader of non-OPEC countries, which relies on oil sales for a majority part of its earnings and as much as 40% of its total revenue. According to estimates, the Russian economy can decline by as much as 6% due to oil price shocks.
The country’s major oil brand Urals traded at its lowest ever since 1998 around $8 per barrel as a clear response to this sudden price shock. In the case of Russia, experts say, honouring the deal of cutting production by around 23% by the beginning of May. Russia’s bounty in oil cannot be compared to those of member countries like Saudi Arabia and Venezuela. As a consequence, high costs will make it highly improbable for private players in Russia to comply with the demands of the newly signed deal.
While many of the causes behind the negative WTI price threaten other indexes as well, what the event of negative crude oil has shown Russia is that this ‘black swan’ event is in fact looming upon its head in practical life. “The June contract for WTI was trading at $14.40 by Tuesday afternoon London time, already down 30% from the previous day and fluctuating continuously.” With high chances of crude prices falling drastically in the coming months as well, comparatively newer entrants like Russia stand to lose out market share as falling prices will lead to stiffer competition among suppliers. For Russia, the costs of production range between $9-$20 which is much greater than say, that of more established players like Saudi Arabia with significantly lower costs around $2-$3 per barrel. The US currently grapples with shortage of storage which could also be the case in Russia’s near future. As and when profit margins fall, Russia which already has a high budget deficit, would be forced to cut down on public spending during times of a global pandemic and this could spell out other problems worsening for the country.
While many of the causes behind the negative WTI price threaten other indexes as well, what the event of negative crude oil has shown Russia is that this ‘black swan’ event is in fact looming upon its head in practical life. “The June contract for WTI was trading at $14.40 by Tuesday afternoon London time, already down 30% from the previous day and fluctuating continuously.” With high chances of crude prices falling drastically in the coming months as well, comparatively newer entrants like Russia stand to lose out market share as falling prices will lead to stiffer competition among suppliers. For Russia, the costs of production range between $9-$20 which is much greater than say, that of more established players like Saudi Arabia with significantly lower costs around $2-$3 per barrel. The US currently grapples with shortage of storage which could also be the case in Russia’s near future. As and when profit margins fall, Russia which already has a high budget deficit, would be forced to cut down on public spending during times of a global pandemic and this could spell out other problems worsening for the country.