An unbelievable number of events have taken place in energy markets over the last few weeks. It has been truly remarkable. The combination of demand loss stemming from COVID-19 economic shut downs, along with the OPEC price war between Saudi Arabia and Russia have created an unprecedented perfect storm that have reamed profound implications in each corner of the industry. Either of these two 3+ sigma events on their own would create devastating impacts to the industry, however, combining them is almost hard to describe in words or numbers. Cash prices for many land locked crude oil markets are rapidly approaching zero. Many producers will soon have no choice but to shut in wells, even if they would pay someone to offtake their product to avoid future production losses because inventory to store the liquids is becoming impossible to find. Defining this moment in history as a “Black Swan” event is almost an understatement. Let’s unpack it:

• WTI Crude Oil closed the 1st quarter of 2020 -$41.11, or -68.3%, at $20.10/barrel on 3/31, down from $60.21 on 12/31/2019. In other words, crude oil just had its worst quarter in history, dating back to 1859 when the first oil well discovery was made in Titusville, PA. WTI hasn’t traded this low since the weeks following 9/11. Prior to that you have to go back to 1999 to find a sub-20 handle.
• RBOB Gasoline futures were even worse, ending the quarter -$1.32, or -70%, closing at $0.5658/gallon. For more color, the quarter’s range high was on 1/8 at $1.9924, while the range low was on 3/23 at $0.4605. This is a range of 76% in a little over two months for a commodity (not a penny stock) that is used in almost all corners of the globe, and has defined human transportation for more than a century.
• Heating Oil futures “outperformed”, ending the quarter – $1.03 (-51%), closing at $0.9925/gallon. Contrary to gasoline and jet fuel, heating oil has been propped up on a relative basis by lingering diesel demand from trucks still pushing product around the country.
• NYMEX Natural Gas futures aren’t exactly comparable as they had already been decimated in November and December due to a warmer than average winter. Nevertheless, NG ended the quarter -$0.54 (-24.7%), closing at $1.643. It’s worth noting that the March low was $1.519, which hasn’t been seen since August, 1995 (the year the first full-length computer animated film by Pixar was released – Toy Story, and the Dow Jones Industrial Average notched its 1st close above 4,000)

Crude oil is now on pace to experience its largest drop in demand ever recorded. The imbalance for the month of April is expected to be roughly 20 million barrels per day, or 20%-25% lower than its previously anticipated demand. A simple look at airplane capacity utilization and road traffic data would seemingly tell you why, but that’s only half of the story. On Saturday, March 7th, as it was apparent that the world was entering a full blown crisis from Covid-19 that would severely impact oil demand, OPEC held an emergency meeting with the goal of extending and deepening their current production cuts in attempt to offset the looming loss of demand. Russia is not a formal member of OPEC, however, they had been participating in OPEC’s planned supply curtailments over the past several years as higher crude oil prices are also in their best interest. At this meeting it was reported that Russia’s oil minister stated that Russia had no interest in extending or deepening the production cuts beyond the end of March as it would be nothing but a bail out for the already struggling, highly leveraged, and marginally higher cost of production US shale oil firms that have been the source of most of the global oil industry’s supply growth for the last several years. The Russians had apparently been planning for this moment, as he also said they have dramatically reduced their cost of production, and reduced the Russian national government’s budget dependence on oil and gas over the last several years. The room was stunned as the man then turned and walked out after putting a proverbial dagger into the heart of the US shale oil industry. Many view this as a form of revenge toward the US because we recently imposed sanctions on Russia’s largest state owned energy company, Rosneft. The following day Saudi Arabia struck back against Russia, and announced its intent to slash their export prices for the month of April by ~$7/barrel. This effectively started an all-out price war between Russia and Saudi Arabia as the two nations vie to reclaim the spot as the world’s leading producer with seemingly no thought or care about near term consequences for these actions. I’m actually not sure what’s bigger at this point – the battle to produce more barrels at less cost, or the battle of egos between MBS and Putin. As of today neither country has blinked, or showed signs of backing off in this price war as both countries have prepared to open the flood gates with production and exports beginning today (4/1).

• 2019 oil production for reference:
  o US – 15 million barrels / day (highest cost of production)
  o Saudi – 12 million barrels / day (lowest cost of production – think 70% less than the US)
  o Russia – 10.8 million barrels / day (lower cost of production than the US, higher than Saudi)
  o World production – 80.6 million barrels / day

US producers are now in a really dark place. Many shale firms are highly levered, and have a marginal cost of production higher than current futures prices, and much higher than current cash prices. Whiting Petroleum (WLL) was the first large shale company to file, which was announced this morning. Storage tanks have begun to fill up across the country, forcing many to start shutting in wells against their will as the volumes simply have nowhere to flow. Production from some late stage reservoirs probably won’t come back online as this damage can be permanent. Land locked, in-land production basins that rely on pipelines to transport volumes to refineries and export outlets are going to be the first impacted and first to shut in because they don’t have access to floating storage like an offshore platform, or wells near the coast. Currently it’s expected that 5 million barrels per day, or ~33% of US production will need to be shut in. Again, this is all about logistics, and has little to do with price.

The resulting drop in oil production is expected to present major upside risks to the calendar year 2021 natural gas market as most of the supply growth was expected to come from associated gas production from producers drilling for oil. Now that wells are being shut-in, not only is associated gas production not going to grow (revisions to producer capex budgets look worse than most YTD price charts), its likely to fall, leading to a drop in daily natural gas supply over the upcoming 18 months. It remains unclear what short term demand impact Covid-19 will have on industrial, power, and LNG export demand pools for natural gas, but regardless, dropping production is something that will cascade beyond the short term economic impacts from the virus. The US natural gas imbalance just got flipped on its head in a major way.

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Will Clark