How the Oil Price Could Fall Below Zero
To get an idea of how through-the-looking-glass this environment is — and just how far gone “normal” is — think about the following data point:
Netflix now has a larger market cap than Exxon Mobil.
It seems impossible, but it’s true. As of this writing, Netflix Inc. (NFLX) is worth $195 billion. Exxon Mobil Corp. (XOM) is worth $166 billion.
Let that sink in for a minute. A company that was stuffing DVD rentals into envelopes by hand 20 years ago — and monetizes comedy specials and Adam Sandler movies today — is 15-20% more valuable than one of the biggest oil companies on the planet.
But if you think that’s wild, try this on for size: We could see oil prices fall below zero by summer.
Among macro traders there is a kind of guessing game, “How low can the price of crude oil go?”
The answer is that the oil price could go negative. This would happen if so much excess oil piled up, with so few places left to put it, that producers wound up paying customers to come and take the oil away.
You might know the commercials for 1-800-GOT-JUNK, where you pay someone to come to your house and haul off the stuff you don’t want. By summer we could see a metaphorical version: 1-800-GOT-OIL.
If this scenario plays out, spot prices and crude oil futures would quote at negative prices. Imagine the oil price — the one that scrolls across a ticker tape on cable finance shows — with a minus sign in front.
The scenario is so likely now that the CME Group — the futures and options exchange giant — has programmers doing an emergency rewrite of its software code so that negative prints can be displayed.
Energy derivatives traders and market makers are also scrambling to revise their formulas. Options contracts aren’t designed for crude oil prices below zero. The math goes haywire if prices go negative.
But this could really happen, and the big shops are taking it seriously.
You might also recall that, on April 9, the Organization of Petroleum Exporting Countries (OPEC) agreed to a historic production cut of 10 million barrels per day. With the announcement of that cut, the short-lived Saudi-Russia oil war came to an end. (Or did it?)
At any rate, the market didn’t care and crude oil prices actually fell even more after the big OPEC announcement.
This happened, in part, because the cartel can’t resist “cheating” on quotas. The enforcement of a production cut is voluntary, with all OPEC members required to do their part, but various members always sneak extra barrels onto the market. So the “10 million barrels” number isn’t actually 10 million.
But the bigger reason the oil market dropped is because OPEC’s cut was a Band-Aid on an ax wound.
The worldwide shutdown has created unprecedented “demand destruction” — meaning people aren’t flying and people aren’t driving, so nobody is using oil.
If you’ve seen pictures of Manhattan, London, Los Angeles, New Delhi, and other once-bustling traffic hubs, they all look like ghost towns. The skies are clearer than they’ve been in decades. It’s a whole lot of not-driving and not-flying.
As a result of all this demand destruction, the chief economist of Trafigura, a large global commodities firm, thinks oil demand could be down by 30 million barrels per day for the month of April.
At 10 million barrels, the OPEC cut (which is already smaller than advertised) is a pittance compared with that massive demand drop.
Then, too, there is nowhere to put the extra oil. The world is configured to burn mass quantities of crude, not store the stuff.
When the price of crude oil first collapsed, long-term buyers stored cheap oil in tanker ships. As the tanker ships filled up — there aren’t that many to go around — they started filling up railroad cars. When the railroad cars fill up, there won’t be anywhere else to go.
It’s the lack of storage that could bring about negative prices. The greater the supply of unused oil, the greater the odds of a total price implosion — with producers paying users to take the stuff off their hands.
The oil price has already fallen roughly 70% in 2020. If it stays below $30 for an extended period of time, the U.S. shale industry will be decimated. If it falls even further, to single digits per barrel or even below zero, the shale patch will be wiped out.
The Trump administration is trying to save U.S. oil producers from oblivion, but they may not be able to.
For example, in yet another through-the-looking-glass development, the U.S. Department of Energy (DOE) is studying a proposal that would pay U.S. oil companies not to drill.
With this wacky plan, the DOE would consider roughly 365 million barrels’ worth of U.S. oil deposits to be a part of the Strategic Petroleum Reserve (SPR), and it would then pay oil and gas companies to leave those deposits in the ground, i.e. do nothing other than sit on them.
But the administration’s plan probably won’t work. They would have to get Congress to approve $5 billion to $10 billion in funding for this “pay them not to drill” scheme, and the political optics would be ugly.
Democrats would call it a straight-up bailout for the oil and gas industry — and they would not be wrong — and would likely either reject the funding outright, or demand comparable funding for clean energy projects (and other pet projects).
Then, too, even if the plan goes forward, 365 million barrels is not a lot in the big scheme of things — at 100 million barrels per day, it was less than four days’ worth of demand in 2019.
To top it all off (no pun intended), the ongoing realities of demand destruction (nobody wants oil right now) would likely dwarf whatever amount U.S oil producers agreed to stop producing in the first place.
Instead of one Band-Aid that says “OPEC,” there would be two, the second one labeled “U.S. shale” — and they would still be too little, too late relative to the size of the oil glut.
So a lifeline to oil producers, as unlikely as it is, wouldn’t solve the actual problem — and thus wouldn’t keep the oil price from falling below zero.
In some places, in fact, the crude oil price is already in single digits.
While the commonly cited WTI crude futures contract is around $20 a barrel as of this writing, regional crude can trade at far lower prices depending on transport dynamics. Crude oil that has to travel through a pipeline, for example, tends to trade at a major discount due to pipelines being jammed.
“The spot price of West Texas Intermediate at Midland fell to just above $10 a barrel on March 30,” the Wall Street Journal reports, “while West Texas Sour at Midland — its harder-to-refine counterpart — fell to around $7 a barrel.” Zero, here we come.
So what are the takeaways for investors here? There are at least two big ones.
First, if oil and gas companies are on your “buy ’em cheap” list, you might want to rethink that.
If crude oil prices go below zero, or just stay below $30 per barrel long enough, a large percentage of oil and gas companies could simply get wiped out — and survivors trading at 50-80% discounts could fall 50-80% more by the end of this year.
Second, the crude oil price is a bellwether for the scope and depth of the “real-economy crisis” — the historic breakage, demand destruction, and supply disruption that is happening via Main Street, not Wall Street, and taking place around the world.
Though the Federal Reserve can pump trillions of liquidity into the markets, and investors wearing rose-colored glasses can temporarily push valuations up, that stuff is a side show compared to the deep structural issues hitting the real economy now.