The oil price meltdown and the risks for US

For the first time in history, the price of oil has dropped below zero. In fact, on Monday, the main oil price index in the United States – the WTI – fell by more than 50 dollars, reaching -37 dollars a barrel. It means that oil sellers are willing to pay to get rid of their stocks.

The reasons for this drop are quite obvious. The effects of the quarantine imposed on much of the world to deal with the coronavirus pandemic have greatly limited the use of cars, airplanes and other public and private means. Less travel means less demand for oil: when the demand for a good falls, it is intuitive enough that its price also drops. To make it fall until it reaches negative territory, however, something special must happen.

In this case, what happened is that the demand for the amount of oil extracted (at least in the United States) has become so low that the owners of the refineries that transform crude oil into gasoline and other fuels have stopped buying it, as they expect that because of the coronavirus pandemic, fuel demand will remain very low for a long time. The oil producers thus found themselves accumulating oil stocks until the physical space available to them to store it was exhausted.

In these days, the situation has reached the point where oil owners, especially producers, have started to spend money to get rid of the stocks they can no longer store. At the moment, an article in the New York Times noted, one of the best businesses in the industry is owning oil tankers: not because it is important to move oil from one side to the other, but simply because an oil tanker is nothing more than a giant floating tank. .

The situation is particularly serious in the United States, a country where the costs of extracting oil are very high. A substantial part of the oil extracted in the country, in fact, is the so-called “shale oil”, the oil extracted with particularly complicated and expensive methods that make it uneconomic to continue production when prices are below 40-50 dollars a barrel.

In theory, producers could simply stop producing oil, thus saving themselves the need to find someone to store it somewhere for a fee, but in practice things are not so simple. An oil well does not turn on or off with a simple switch. Stopping production takes time and even more time requires restarting it, not to mention the risk that the well will no longer return to previous productivity.

If things continue like this, the producers will inevitably be forced to shut down, but so far many have tried – or have been forced – to try to resist in an extremely hostile market, hoping to overcome the difficulties without having to stop production, so to be ready to restart as soon as the situation recovers.

Things could improve slightly in the coming months following the agreement reached by the organization of the oil-producing countries (OPEC) and Russia, to reduce production by 10 percent, so as to try to support prices (at the early March, the decision by these two blocs not to cut production for reasons of trade war had been one of the causes of the first collapse in oil prices). The cut decided in early April is the most significant in history, but has failed to prevent the collapse of prices in recent days.

To see prices return to a stable level, Americans will probably also have to significantly reduce their production. Unlike Russia and Saudi Arabia, however, American production is not based on state-controlled companies, which are easy to order increases or decreases, it is carried out by hundreds of private companies that in the event of a prolonged crisis are likely to go into bankruptcy.

The reduction in American production, therefore, is likely to be caused by a series of chain failures in the sector.

By: Domenico Greco

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