Why Crude Oil Prices Fell Below Zero: Understand Your 2020 Shipping Budget
May 22, 2020
Uncertainty is inevitable in nearly any industry—from changes in the stock market to the price of materials and commodities to freight rates, and beyond. It is the cost of doing business, and for those that can predict and navigate it well, it can even become a competitive advantage.
But for industries typically accustomed to more predictable outcomes, dramatic changes in supply, demand, and price, can have more costly implications for other sectors affiliated with it. In the case of crude oil, one of the world’s most valued commodities that influences the dynamics of dozens of refined products and enables a myriad of services, millions of people and organizations hinge on crude oil price behavior.
In 2020, that price behavior has behaved erratically, and for the first time in its history dipped below $0 per barrel turning the oil industry on its head.
The COVID-19 market shock saw commodities prices plummet as demand for goods and supply chains were upended to begin 2020. Through April, the energy sector was hardest hit with the benchmark West Texas Intermediate Crude Oil futures May contract price falling as much as 161 percent below its price to begin the year. How might a commodity price fall over 100 percent? On April 20, WTI closed at -$37.63 per barrel, after it began the year with a close of $61.18 per barrel.
What happened to crude oil prices? Why? And how will they continue to influence an organization’s bottom line?
What was 2020’s Original Crude Oil Outlook?
The 2020 market outlook for crude oil was supposed to be supported by improved economic performance following the 2019 market experience. World GDP was projected by the International Monetary Fund (IMF) to increase from a 3.0 percent annualized rate in 2019 to 3.4 percent in 2020. The trade war between the U.S. and China seemed to be navigating toward compromise, and geopolitical risk from countries like Iran, Venezuela, and Libya was also thought to support crude prices in the year ahead. The median crude oil forecast across firms reporting within Bloomberg Intelligence was $56.68, which was within $1 per barrel of 2019 prices. Sentiment was looking up.
In addition to macro trends, many energy analysts expected prices to jump on January 1, 2020 in response to the implementation of the International Maritime Organization’s (IMO) new sulfur regulations. Breakthrough’s forecasts of the event pointed to price support for low-sulfur fuel but noted the event would fall short of price spikes and price premiums would fade in the first half of 2020.
WTI prices had not fallen below $40 per barrel since August 2016 despite record-breaking U.S. production levels, OPEC+ decisions that supported the market, and healthy economic growth across developed economies—particularly in the U.S.—so there was little reason to believe oil prices would plummet in 2020.
Why Did Crude Oil Prices Fall Below Zero?
The unprecedented dip in prices is a result of two historic disruptions that occurred simultaneously—both of which are tightly entwined with the impacts of the novel strain of coronavirus (COVID-19). Never have both supply and demand swung so drastically to contribute to a severely oversupplied crude oil market.
How the Coronavirus Destroyed Demand for Crude Oil Products
Demand Shocks Diminished the Need for Crude Oil Refined Products Globally
As most indicators were trending up, a key disruption seen almost unilaterally across markets was the introduction and rampant spread of COVID-19. The threat of the virus and its surrounding unknowns led first to lockdowns in its originating epicenter of Wuhan, China, and has since rippled across the globe.
One way the virus is a unique disruption for the shipping community is because it very specifically impedes consumers’ ability to purchase goods of all kinds. With lockdown measures in place through Q1 and most of April and May, people could not frequent retail locations to their typical degree, and non-essential, durable, and luxury goods took a backseat to necessities.
Nondurable goods within the Breakthrough Network have maintained robust year-over-year growth to date, while durable goods demand fell dramatically. These trends particularly separated when stay at home orders took effect across many states and led to an initial surge in freight volume for consumer-packaged goods and other necessities—like pantry items, and paper products—reflected in Breakthrough data in March.
Staying at Home Eliminated Travel-Related Fuel Demand Across Transport Modes
Another way that COVID-19 contributed to steep demand-side disruption is in the limits it imposed on travel of all kinds. Diesel demand dropped less than other fuel types because of continued commercial trucking, falling by 20 percent—which is still notable. Jet fuel demand plummeted 65 percent as air travel ground to a near-halt and gasoline similarly tanked falling 40 percent as passenger vehicles remained parked, according to the EIA.
The connection to crude oil is apparent because various fuel types and other products are all refined from the same store of crude oil.
Read more about crude oil’s refined product outputs in, “What’s in Your Crude Oil Barrel?”
Supply Shocks Tipped the Scale Further Out of Balance
High Production Flooded a Market with Historically Low Demand
Just as consumer demand for crude oil and its refined products came to a screeching halt, several parties in the global crude oil market hit high production volumes in February. The U.S. pumped 13.1 mmbd for the first time in its history while OPEC+ simultaneously found disagreement and increased their production.
An early March meeting between OPEC and its allies (OPEC+) was expected to conclude with a renewed strategy to balance the oil market and stabilize prices amid COVID-19’s international expansion. Instead, it ended without Russian agreement, inciting Saudi Arabia’s declaration of a price war, verbal end of the OPEC+ alliance, and significantly increased production.
The abrupt departure of Saudi Arabia, Russia, and other producers from a policy of restraining supply to support prices fundamentally changed market economics. The chart above shows how this shift in policy, coupled with severe demand destruction created a severely imbalanced oil market.
Where do you put millions of barrels of oversupplied crude oil?
With so much of the crude oil supply flooding the market, and little demand for its refined products, a very practical constraint quickly emerged: where do you store crude oil that no one can readily use?
Global crude oil terminals and pipelines quickly became saturated, and stakeholders across industries had to innovate and adapt quickly to bear the burden of their crude oil storage infrastructure. By March, Rystad Energy estimated 76 percent of the world’s available oil storage capacity was already full.
As if the historic supply and demand shocks didn’t create enough of a perfect storm of oil price chaos, oil contracts were quickly approaching their execution. This posed a threat to commodities traders that held those contracts. Often traders intend to resell contracts before their execution, never actually hoping to take delivery of crude oil. As contracts neared their execution, traders found themselves in the unique position of having no market to sell them to, while also possessing no means of taking delivery of the physical crude oil. This further stressed crude oil storage infrastructure, while pushing prices desperately lower.
It was this anticipation that was the final push to send crude oil prices careening below zero – to a closing price basement of -$37.63 per barrel.
What Can Shippers Expect for Crude Oil Prices for the Rest of 2020?
We have undoubtedly experienced the trough of the oil market due to COVID-19. Entering summer, the crude oil and refined product markets have seen ascending prices thanks to massive supply-side adjustments across major oil producers and refiners.
U.S. oil production fell 1.5 mmbd from February to May (see the chart below) while the U.S. oil rig count fell below 300 to its lowest recorded level in weekly data by Baker Hughes. Other oil producers cut production, too. The OPEC+ alliance coordinated a crude oil production cut of 9.7 mmbd during May and June—the highest agreed upon production cut in the cartel’s history.
Refinery utilization within the U.S. fell below 70 percent in the month of May due to soaring inventories of gasoline, diesel, and jet fuel. Refineries have routinely operated at higher than 90 percent in May in recent years to prepare for the summer driving season. These developments will gradually allow inventories to be drawn and fuel prices to climb.
While there is consensus regarding signals sending oil and refined product prices higher, the pace of their climb and its ultimate peak is uncertain. Clear signals can prove to be elusive in energy markets, so shippers can use current market conditions to the advantage of future strategy.
Connecting Global Crude Oil Price Behavior to Shipping Strategies
The macaroni and cheese on a store shelf or family spring break trips to Cabo may feel far removed from an oil cartel and global crude oil production, but they are all connected by the underlying refined products that enable them. The price of crude oil commonly accounts for between 40 and 60 percent of the cost of ultra-low-sulfur diesel consumed by heavy-duty trucks. As such, crude oil plays a significant role in the cost of doing business and can be the cause of millions of dollars within transportation budgets.