Five things to know about the turmoil in the oil market

Even for an industry already hit hard by the coronavirus, this week was especially devastating for the oil business.

Oil markets hit a historic first this week when prices dropped so low they went negative, falling to as little as negative $40 a barrel.

With negative pricing, crude has fallen by more than $100 this year, from roughly $60 per barrel at the beginning of the year. 

Prices have since rebounded into profit, but the industry is far from being in the clear.

Here are five things to know about the wild swings, what may be on the way and why it matters.

The big picture: A supply and demand problem

Well before the virus had taken center stage, Russia and Saudi Arabia were feuding for market dominance, increasing their production and flooding the market with a glut of oil.

The ill-timed production increase came as the virus began shutting down economies in Europe and then the U.S. 

Demand for all types of oil is now down 30 percent as people shelter in place.

Supply in the U.S., however, remains abundant as oil producers have cut their production by around 5 percent over the last month.

There is some method to their madness. Continuing production is the only way for oil companies to make money, even if it just means their losses won’t be quite as deep. They also fear cutting production so much they won’t be making enough money once prices improve to start drilling new wells. 

But those two factors have led to a very real problem — oil companies are running out of space for their product.

A fear of being saddled with oil and no place to store it

That lack of storage space caused extreme market reactions Monday as traders rushed to free themselves of contracts for oil they weren’t physically able to take possession of.

Traders have until around the 20th of the month to buy and sell oil contracts.

But not everyone trading oil contracts has the infrastructure to pick it up or store it — leaving paper traders scrambling to find buyers capable of storing oil. 

The negative price reflected traders’ willingness to pay others to take their oil contracts and figure out what to do with the product.

“Once the month rolls, if you haven’t closed out your positions, you’re expected to go to delivery, and if you’re not involved in the physical market and have no means to make or take delivery, you’re caught at the whim of those who trade in both the physical and financial markets, and that’s what caused the negative pricing,” said David Braziel, president of RBN Energy.

Though prices crept back into profitability again Tuesday, negative pricing could very well repeat itself because storage space is still so limited.

Rystad Energy estimates there may be only 21 million barrels’ worth of free storage left in a country still producing 12 million barrels of oil a day — a feature certain to keep prices low. 

“We’ve seen negative $37 oil, so it’s a punch in the face that’s a reminder of what can happen,” said Jim Burkhard, vice president and head of oil markets at IHS Markit. “So some investors have seen what can happen and are likely to perhaps learn from that, which could prevent another bout of deeply negative pricing, but with such an imbalance between supply and demand, it could happen again.”

U.S. oil companies are particularly sensitive to big price drops

Those low prices are particularly damaging for U.S. oil producers because of their reliance on fracking.

Nearly all oil in the U.S. is produced using the controversial method of pushing water and chemicals deep into rock crevices to push out oil.

The process itself is more expensive — it might cost as much as $10 million to drill a fracked well versus $2 million for one with a conventional bobbing derrick. 

But fracked wells also bring more of their oil to the surface within the first year, with their short lifespan making each well much more tied to market prices.

“The best day of life for an oil and gas well is its birthday,” when oil rushes to the surface, Raoul LeBlanc, an oil industry expert at IHS Markit, previously told The Hill. But after that, “They decline relentlessly.”

Oil producers could “shut in” wells, essentially allowing them to pause production, but beyond the other financial considerations, doing so risks damaging the well’s productivity. 

Even as prices rebound, the short-term future of the oil industry doesn’t look good  

While oil prices have lifted with the start of a new contract month, market conditions have otherwise not changed very much, i.e., there is still much more supply than demand.

And efforts that have sought to change that haven’t been able to make enough of a difference.

A coalition of oil-producing countries known as OPEC+ agreed earlier this month to reduce oil production by 10 million barrels a day, a roughly 10 percent drop in the daily global supply.

But those cuts don’t kick in until May, and so far the agreement seems only to have helped stabilize prices for international benchmark Brent crude, as the European supply is closer to many of the OPEC+ countries.

The Trump administration has also directed Cabinet agencies to look at opening up lines of funding for oil companies — something that has also been requested by numerous Republican lawmakers. But Treasury Secretary Steven Mnuchin said he faces legal limitations to doing so. 

“That will be something we may need to go back to Congress and get additional funding for,” he told reporters Tuesday.

The Department of Energy has also begun the process of renting 23 million barrels of storage space to oil companies to be paid for in oil.

But experts say the only surefire way to really start burning through the excess supply is by reopening the economy to increase demand.

“The only thing that’s really going to help is getting demand back online, which is going to require getting the country back open and people back in cars,” Braziel said, a process that could take months.

Enjoy the low prices, but understand the downside

The low prices for crude have of course filtered down to the pump. Gas was selling at an average price of about $1.80 a gallon this week and fell as low as $0.78 at a gas station in rural Minnesota earlier this month. 

But while that may help consumers save when filling up, the disruption to oil markets is a symptom of larger economic woes.

More directly, that will lead to losses on gas taxes and other revenue for cash-strapped state governments. It’s particularly bad news for big oil-producing states that are heavily reliant on oil to fund operations, such as North Dakota, Wyoming and New Mexico.

And lawmakers from oil-producing states have repeatedly warned of the economic impacts of job loss within the 10 million-employee industry.

“We face a real and present danger of seeing hundreds, if not thousands of oil producers shuttering, an event that will profoundly and negatively impact the industry, its financial partners and consumers for years to come. The prospect of once again becoming reliant on oil imports is an unacceptable situation and we should do all we can to avoid it,” lawmakers wrote in a letter spearheaded by Sen. Kevin Cramer (R-N.D.).

Even the climate may not benefit from low oil prices, as it makes it harder for other technology to stay cost competitive. 

“If gasoline prices are low, there’s a worry it will slow the adoption of electrical vehicles or other clean energy solutions,” Tim Donaghy with Greenpeace previously told The Hill.