What does a negative oil price mean for markets and the lockdown economy?
In this bubble of lockdown and social distancing, where tangible contact has become so abstract and virtual, the oil market is suffering from a rare plight of physicality. West Texas Intermediary crude – aka US ‘light, sweet’ oil – prices crashed into negative territory during Monday's dealing. As if they were old settees or washing machines, people were effectively being paid to take barrels of the black stuff away. The anomalous descent into negative prices was largely a machination of the futures market. And it essentially reveals the pain of derivative traders caught in the final hours of expiring contracts which were written in very different economic circumstances. Stuck without the means or desire to take physical delivery of the crude purchased via futures contracts, the pricing oddity reveals a sort of ‘get me out at any cost’ capitulation. As weird as the pricing looks, it barely belies the fundamental problem in the physical oil market. Data released last week confirmed both record inventory volumes and record low gasoline demand. America’s primary crude hub at Cushing, Oklahoma is running out of storage space. READ: Why the spread between WTI and Brent prices is so high “With storage filling up, the price of oil for immediate delivery has tanked,” said Saxo Bank analyst Ole Hansen. “The near US$9 spread between May and June is a clear sign that physical oil traders have no space available.” Saxo says only a major, fundamental change (like producers being forced out of business or a significant improvement in demand) can now arrest the slide. It is a reminder for commodities traders and commentators, who are much accustomed to an abstract and macro view of oil, that a real industry and real infrastructure exists beneath all the noise of the capital markets and derivative market jiggery-pokery. For all the chatter, theorising and trading, frankly, the closest most ever come to actual petroleum is when on the forecourt. Right now, the price of an American barrel is at a multi-decade low as petroleum consumption has come to a practical standstill. It could be easy to complicate and aggrandise, but, instead, let's borrow and bastardise a lazy market makers adage - “there’s just more producers than users, mate”. But, isn’t cheap oil good for consumers? Crude prices being so low reveals facets of the economy that are at best awkward and idiosyncratic, if outright not problematic. On the surface, deeply discounted fuel should be great news, especially as we find ourselves at the precipice of recession and maybe even depression. It means we can fill our cars on the cheap. Lower haulage costs would, at least in theory, mean cheaper food and consumer goods. It could help margins among the embattled retailers, and, generally, put a bit of bang onto every consumers’ buck. Doesn’t it sound positive and doesn’t it seems simple to say cheap oil is good for consumers. But, this basic observation vastly overlooks the obvious abnormal circumstances that brought crude here in the first place. On a personal level, a recent delivery of kerosene heating oil cost around 45% less than the same order before Christmas - which was great! It is a small win. But, it’s not enough to see any individual better off in any meaningful way, financially and economically. By analogy, it would be true that a new pair of socks would last 100% longer if my left foot was in plaster, but, that’s not incentive to spend the rest of today practising Mui Thai on the wall. Oil dividends underpin almost everyone’s personal finances Oil money permeates deep into the economy, particularly as the supermajors like BP and Royal Dutch Shell are vital and typically iron-clad dividend payers. These stocks are cornerstones in all kinds of portfolios, not least those that prop up pension funds across the City. Given that pretty much all other blue-chips have so far had to capitulate to either cut or suspend dividends, with about £30bn in payments for 2020 now missing, this latest oil price slump may prove to be another hammer blow to the equity-centric financial system. Investment is still needed to avoid bust-and-boom volatility Setting aside the seizure triggered by coronavirus lockdown, which sees consumption at a standstill, the crude market is usually dynamic. Demand is persistent (normally) and every barrel consumed from reserves must be replaced for the market to at least standstill. It is the reason that capital investment is typically strong and ever-present year in, year out. Moreover, the discovery and development of new oil fields is complex and takes many years of work and investment. A lack of investment today creates a supply shortage in the future. In due course, that turns to a bubble of higher prices, driving over-investment to tip the market back into oversupply. A glance at a chart of historic crude prices tells you that whilst coronavirus is unprecedented, oil prices rarely stay in goldilocks territory very long. Quite what happens next remains unclear, especially as only a vanishingly small number of producers will be able to operate profitability at current real-time prices. A hand grenade for decarbonisation and renewables Few concepts collide quite as awkwardly as the decarbonisation lobby’s need for expensive oil. Most honest and pragmatic observers of the industry probably agree on at least a few truisms. One would be that alternative and cleaner sources of fuel and energy would be welcomed by most - and, increasingly, it appears that even ‘big oil’ producers have ambitions to play a role as investors and incubators of new technologies. Another would be that, ideally, alternative renewable sources of energy should aim to be economically attractive versus to carbon-based fuels. The third, perhaps more controversially, is that without subsidy renewable energy has so far struggled to beat carbon fuel in terms of pricing. Indeed, expensive crude oil in recent years helped make a compelling case for those that had otherwise dubious environmental perspectives. The opposite also appears true, too. The availability of cheap coal is, for example, one of the biggest impediments to reducing emissions in highly populated and often cash-strapped emerging economies. Environmentalists will, rightly, be cheered as lockdown has sparked some resurgence of some ecosystems as polluting humans stay indoors. When this is all over, science will be able to gather valuable environmental and climate data, which may deliver very significant insights. Lockdown will no doubt represent a fascinating demonstration of what happens, for example, once the world’s air traffic is grounded and jet fuel remains unburnt. We will see what it is like for the environment when 80% of petrol and diesel cars stay off the roads. These narratives may well appear striking and positive. But, will any of it change economics? US crude prices are down more than 80% in 2020 to date. However, has the cost of generating electricity to power a Tesla car changed materially over the same timeframe? If I were to suggest the best way to cut the costs of running an electric car might be to hook it up a diesel generator, I would only be half joking. Writing this in lockdown, however, the only thing that can really be certain is that the volatility and uncertainty is far from over. So let’s see what the prices say tomorrow!Full Article