Oil May Never Fully Recover From This Crisis

It’s a rule of thumb among epidemiologists that every epidemic is different and could be laden with surprises. It now seems the same applies to economic crises.

During the last downturn, the one that started from the subprime mortgage crisis, the hardest-hit industries were, understandably, real estate and banking. Now, it’s oil and gas in the crosshairs, and nobody knows if the industry will ever be able to recover fully. Just like the coronavirus epidemic that started in China and within two months spread all over the world forcing people to stay at home, the March OPEC+ meeting that was supposed to lead to a deeper round of production cuts ended in a price war. It couldn’t have come at a worse time, but nobody could anticipate the lockdowns and shelter-in-place orders at the time.

Since then, the odds have stacked up against oil and, to a lesser extent, against gas. Gas demand is more resilient than oil demand and likely to rebound faster. In oil, on the other hand, the uncertainty remains heightened, and that’s despite the recent price rally spurred on by a combination of favorable factors.

European countries began to emerge from their lockdowns earlier this month. People began to move between places again. U.S. gasoline inventories booked an unexpected decline three weeks ago amid the lockdown that had decimated fuel demand. Then crude oil stockpiles began to decline as states started to ease their lockdowns. Following the Energy Information Administration’s Wednesday petroleum status report, West Texas Intermediate jumped closer to $40 a barrel, a price level not seen in months. Can it last? Nobody knows.

Demand should be improving as people start venturing out first and then traveling again. But as medical experts warn that the premature reopening of the U.S. economy could have even more disastrous consequences of an extended national lockdown. Besides the obvious harm, a second wave of infections, if realized, could once again weigh on oil demand.

If such a second wave occurs, it would come at an even worse time for U.S. drillers. Some of them are probably planning to start ramping up production to generate some much-needed cash and avoid a permanent loss of production from shut-in wells. After all, they’ve done great so far: the combined production cuts in the U.S. and Canada are about 3.5-4.5 million bpd as of early May. But if they start ramping up and prices slump again because of a second wave of Covid-19, it’s easy to picture the chaos. Oil wells, after all, are not a light switch you can flip on and off.

The issue of a second wave of infections certainly casts a shadow over the immediate—and the long term—future of oil, but there is also the issue of oil storage. Sure, prices have been improving on those early signs of improving demand, but they have been mainly improving because of the lower production reports and general optimism that things will eventually get better. Until they do, however, there are still hundreds of millions of crude oil barrels sitting in storage.

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“I look at where we are today. The reason we are excited is we are past the worst point. If you think about the moment in the crisis where demand was at the lowest point and supplies were at the highest point, we’re past that,” Bank of America’s head of commodities, Francisco Blanch, told CNBC this week. “But we’re not out of the woods,” he added.

Ten years ago, oil was one of the first industries to emerge from the crisis relatively unscathed, with demand strong and prices in the $80s. Now, it is likely to be among the last ones to recover from the double blow of demand destruction by the pandemic and the excess supply resulting from excessive production. And it may never recover fully.

Original Post

Written By: OilPrice.com