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Disaster on the Horizon

Disaster on the Horizon

Introduction

It doesn’t matter where you look, capital budgets are being cut and oil industry spending is being slashed as West Texas Intermediate, the U.S. benchmark, has shed close to 60 percent of its value since the start of the year [1]. But these spending cuts might not be enough when the inevitable occurs – global oil storage reaching capacity. What then? Disaster appears to be on the horizon as the oil industry is preparing for the possibility of oil dropping to $10/bbl. With the world increasingly oversupplied, oil is getting put into storage for a later time in hopes of a future when prices begin to stabilize.  

Supply/Demand Imbalance 

The COVID-19 virus and the ongoing oil price war have created such a large global supply surplus that oversupply has led to a rapid decrease in global oil storage availability.  It is a two pronged problem: the COVID-19 pandemic has dramatically diminished global oil demand while both Saudi Arabia and Russia have promised to flood the market with additional production. Saudi Arabia alone has promised to supply 12.3 million barrels per day (mb/d) – not just in April but also over the next few months; dramatically above their current production levels of less than 10 mb/d. Russia has also promised an additional 0.3-0.5 mb/d [4]. 

Bottom line, the world is already oversupplied and things are about to get worse. Storage facilities – both on land and offshore – are already filling up and Saudi has not even begun their deliveries of crude to the market. According to the International Energy Agency, global oil supply was already expected to exceed demand by 3.5 million barrels per day this quarter [3]. But that number is expected to rise significantly when OPEC member nations further boost their output as production limits expire. In fact, with the spread of the coronavirus and the increase in production from Saudi Arabia and Russia, estimates predict oil consumption could be off by over 10 mb/d [2]. With the gap between supply and demand growing every day, it is only a matter of time before global oil storage is completely filled. Until supply and demand come back into balance, the oil will keep stacking up worldwide. 

Storage Capacity 

A Paris-based energy analytics firm, Kayrros, predicts over 65 percent of the “world’s total 5.7 billion barrels of oil storage is currently in use” [3]. Utilizing satellite technology, chief analysts at Kayrros predict global oil storage could be completely full in a mere four months. Once global oil storage is full, there will be nowhere for surplus oil to go. While this may seem like an obvious statement, it needs to be addressed. As storage reaches capacity, a slide toward $10/bbl is possible [5]. If the analytical experts scenario of $10/bbl comes to fruition, even the lowest cost producers would be financially challenged. At such ultra-low prices the sale price would be lower than the costs of production [6]. Clearly that is not a scenario that could continue indefinitely. 

Production Cuts

With the COVID-19 pandemic showing no signs of global relief, it doesn’t matter how cheap crude is. If people are not driving, flying or consuming anything aside from the bare essentials, there is no demand boost from low prices [2]. The only way to bring supply and demand back into balance is to reduce supply by shutting-in production. JBC Energy noted that no one “can exactly be sure that production will be shut-in fast enough to not overwhelm our ability to store oil. In such an environment, it is possible for Brent prices to briefly go to $10 per barrel as it was back in 1986 or 1998” [2].  Goldman Sachs estimates that Chevron needs $50 per barrel in order to cover spending and its dividend. ExxonMobil, on the other hand, needs something like $70 [5]. At a $10 price environment, not only can these companies not survive, the oil and gas industry will suffer the same fate. 

Conclusion

Despite the leap in price of storage, producers are still flooding these facilities in hopes for a future with higher prices. When these facilities become full, experts predict a slide to $10 oil, the lowest it has been in the 21st century. With a global pandemic controlling demand into the foreseeable future, there appears to be only one solution: solve the supply problem that is currently plaguing the oil industry. 

References:

[1] https://oilprice.com/Energy/Crude-Oil/Saudi-Arabia-And-The-US-Could-Form-The-Worlds-Newest-Oil-Cartel.html

[2] https://oilprice.com/Energy/Energy-General/Oil-Majors-Are-Preparing-For-10-Oil.html

[3] https://www.alaskajournal.com/2020-03-24/global-oil-storage-capacity-shrinks-amid-supply-glut

[4] https://oilprice.com/Energy/Energy-General/Oil-Could-Crash-To-10-As-World-Runs-Out-Of-Storage.html

[5] https://www.reuters.com/article/us-health-coronavirus-oil-surplus/oil-industry-may-fill-global-storage-in-months-as-record-glut-builds-idUSKBN2152WK

[6] https://www.forbes.com/sites/simonconstable/2020/03/24/oil-prices-could-plunge-to-10-a-barrel-swamp-storage-capacity-report-says/#5e052ddb35ac

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1 Comment

  • Reply Back to the Future – RARE PETRO April 7, 2020 at 4:18 pm

    […] case you missed our last post, Disaster on the Horizon, there is an enormous, unavoidable issue looming on the horizon for the oil and gas industry […]

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