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Could oil prices fall below zero?

Amid shutdowns across the world to halt the spread of coronavirus, global demand was predicted to be almost 23% lower this month than a year ago, according to research firm Rystad Energy.

Article originally published by The Week. Hargreaves Lansdown is not responsible for its content or accuracy and may not share the author's views. News and research are not personal recommendations to deal. All investments can fall in value so you could get back less than you invest.

The complex Saudi-Russian oil war is flooding the market while Covid-19 means it isn’t being used

Amid shutdowns across the world to halt the spread of coronavirus, global demand was predicted to be almost 23% lower this month than a year ago, according to research firm Rystad Energy.

Despite this, Russia and Saudi Arabia have been letting the global supply of oil flow ever faster, causing the price to plummet.

While global oil prices jumped overnight after US President Donald Trump said he expected Saudi Arabia and Russia to reach a deal soon to end their oil war, others have warned that the price of crude could fall below zero.

What is going on?

Both Moscow and Riyadh believe they have more to gain than lose by continuing to drive prices down - as weaker competitors buckle from falling profits, both oil-producing giants will move to increase their share of the global market.

There is a bigger strategic objective too. Russia, in particular, wants to check the rapid expansion of the American oil industry, pioneered as it is by the expensive hydraulic fracturing - or fracking - process, which relies on high oil prices to turn a profit.

In the meantime, however, as supply continues unabated, and buyers take advantage of rock-bottom prices, the world’s storage capacity for oil is quickly filling up.

When this happens, some may even start paying to have others take barrels off their hands. In short, the price of oil will drop below zero.

This is already happening in some areas. Last week, in an “obscure corner of the American physical oil market”, oil prices turned negative, meaning consumers were requesting payment to take the oil off producers’ hands, Bloomberg reports.

The main factor that will determine if this happens on a larger scale will be global storage capacity - if oil literally has nowhere to be stored, owners will start paying to move it on.

How close are we to full storage capacity?

With motorways clear, airliners grounded and populations around the world compelled to limit their economic activity, the steady flow of oil ensured by the Russia-Saudi stand-off is not being used, and storage facilities are reaching their limit.

“The fuller storage capacity gets, the closer oil prices will get to zero. When and if capacity is maxed out, oil prices will turn negative,” said the Financial Times on Wednesday. “On current trends, this could happen within months if not weeks.”

CNN said that one storage option could be to load all that extra crude onto ships. “About 20% of the global fleet of very large crude carriers (VLCCs) could become floating storage. But even that would not absorb the surplus. In April, some 6 million barrels per day of ‘homeless crude’ might literally have nowhere to go… a figure that would rise to 7 million barrels per day in May,” it said.

Why fight an oil price war during a pandemic?

The oil price war between Russia and Saudi Arabia is a game of chicken both sides are willing to play because, in the end, neither of them are the real losers from the crisis.

High oil prices benefit oil producers, but they also allow new producers to enter the market. In particular, propelled by new technologies like improved hydraulic fracturing, but also by high oil prices, the United States has seen its oil production skyrocket in the last decade.

In 2018, they overtook the Saudis and the Russians to become the world’s largest oil producer. This trend has only continued, and the newcomer now produces 19%t of the world’s oil, compared to Saudi Arabia’s 12%, and Russia’s 11%.

Between the late 1990s and 2018, the latter two were the world’s leading oil producers. An arrangement by Opec+ (members of the Organization of the Petroleum Exporting Countries as well as non-Opec producers) meant they curbed their production to reduce global supply, thereby controlling the price of crude and ensuring their output was lucrative.

The US, however, was never part of this arrangement, and has as a result benefited - its booming shale oil sector in particular - from the high price of oil, without ever having to curb its production, as its competitors have.

Frustrated by this set of circumstances, and knowing that their power was being threatened by a burgeoning US oil industry, it was Russia that collapsed Opec+ in Vienna last month. The Saudis, unwilling to be the only major producer cutting production, went on the offensive.

Russia and Saudi Arabia will certainly suffer from the low prices, but the vast cash reserves secured from decades of oil-selling mean they can weather the storm. Their pain will be short-term, but in the long-term they will increase their global market share, and US oil will no longer be able to expand production while the rest of the world cuts it to prop up prices.

There will be collateral damage. In particular, Iran and Venezuela - normally allies of Russia - are far more dependent on oil exports in the short term, and will see a major contraction of their oil industries as they are undercut by plummeting prices.

By ensuring a surge in production just as the coronavirus crashes demand for oil, however, Russia is hoping to bring US oil down to size, and perhaps even force it to play its part reducing production to bring prices back up.

Last night, Donald Trump said he had spoken to both countries’ leaders and said he expected them to “work it out over the next few days”.

“It’s very bad for Russia, it’s very bad for Saudi Arabia. I mean, it’s very bad for both. I think they’re going to make a deal,” he said.

Global oil prices later rose, but the BBC says: “Traders have suggested that prices may also have been boosted by expectations that American shale oil producers, which have relatively high production costs, are coming under pressure to cut production.”

Reuters said that other analysts “cautioned there is still a long way to go before any output cut agreement is struck”.


This article was from The Week and was legally licensed through the NewsCred publisher network. Please direct all licensing questions to legal@newscred.com.

Article originally published by The Week. Hargreaves Lansdown is not responsible for its content or accuracy and may not share the author's views. News and research are not personal recommendations to deal. All investments can fall in value so you could get back less than you invest.

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