How Many Barrels of Oil Are You Willing to Take?

crude oil storage, Sunoco
Department of Energy crude oil storage tanks at the Sunoco terminal near Nederland, TX. Photo credit: U.S. Department of Energy / Flickr
Reading Time: 18 minutes

For the first time in history, oil prices fell below zero on Monday. The “negative” price point meant that, in theory, if you’d bought oil on Tuesday, you would have gotten that oil and a bunch of money on top. 

The oil price crash was a Black Swan event, precipitated in part by the current global pandemic that is pushing the world’s energy markets into uncharted territory. 

While the focus has been on the price of a barrel of oil, the ripple effects will be felt far and wide. Among the sectors impacted are electricity markets (which should see lower prices), the coal market (which stands to benefit), and the nuclear industry (which could suffer). It may be a devastating setback for the growth of renewables. And the almost unlimited financing of shale oil production could also be affected.

Our guest on this week’s WhoWhatWhy podcast is Alex Gilbert, one of the nation’s foremost energy analysts. He has published dozens of academic articles and comes armed with degrees in energy regulation and law, climate law and environmental studies, and international relations.  

Gilbert explains how we came to the current oil glut, why even the US Strategic Petroleum Reserve is full, and why the consequences of cutting back on production could haunt us for years.

He details the geopolitical consequences of too much oil, the democratization of oil pricing, and how the Saudis, the Russians, and the United Arab Emirates have overplayed their hands. He completely dismisses the idea of US energy independence and shows how we could be looking at $100 to $150 for a barrel of oil in two to three years.

Gilbert warns us that while the air is cleaner and carbon emissions have been reduced by the current decrease in fossil fuel use, the environmental benefits are temporary at best. In the long run, the current crisis could seriously harm the prospects for renewable energy and, ultimately, for dealing with climate change.

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Full Text Transcript:

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Jeff Schechtman: Welcome to the WhoWhatWhy Podcast. I’m your host, Jeff Schechtman.

For the first time ever, oil prices fell below zero on Monday, marking a historic new low and an unprecedented event. To be accurate, oil prices have been falling since the beginning of the year, and the onset of the pandemic just sends us deeper into uncharted territory. But that’s only part of the complex and deeply interconnected global energy picture. Impacts are being felt in the electricity market, the coal and nuclear industry, natural gas, expanding efforts in construction in renewables and the overlay to all of it is the environmental and climate change impact both short and long-term. We’re going to talk about all of this today with my guest, Alex Gilbert. He is co-founder of Spark Library, an energy research and data firm based in Washington. Previously he performed econometric analysis of electricity, natural gas and oil markets. He’s been published in multiple academic journals on energy policy and has a master’s degree in energy regulation in law and degrees in climate law and environmental studies and international relations.

Jeff Schechtman: He’s a project manager at the Nuclear Innovation Alliance and a fellow at the Payne Institute. It is my pleasure to welcome Alex Gilbert to the WhoWhatWhy Podcast. Alex, thanks so much for joining us.
Alex Gilbert: Thank you.
Jeff Schechtman: I want to start with the most obvious thing that people have been paying attention to this week, the seemingly black swan event that took place with regards to the oil markets and more specifically to May contracts. Talk a little bit first about what that was really all about and what it meant.
Alex Gilbert: Yes, of course. So in order to understand what’s happening with oil markets and why things are both relatively frightening and uncertain, but also we’ve not actually seen major impacts yet, they need to understand how oil contracting works. So for the United States, we have one major benchmark contracting hub and that’s WTI, West Texas Intermediate, and that is delivered at Cushing in Oklahoma. It’s sometimes called the pipeline capital of the world because there’s so many pipelines going in and out and there’s a large oil storage facility there. So when you have an oil contract, when you sell an oil contract to a buyer, as a seller, you have an obligation to deliver 1000 barrels of oil to Cushing over the course of a specific month. As a buyer or a holder of a contract, you have obligation to receive that thousand barrels of oil. So basically it’s a way for you to sell oil into the future or buy oil in the future and guarantee your lock-in prices.
Alex Gilbert: Now, the way that we use markets to balance between buyers and sellers, we have a lot of oil traders that participate in oil markets. This provides liquidity so that a buyer and a seller don’t necessarily have to be the people that physically handle the oil and prices can have good price discovery. So what happened earlier this week on Monday specifically, the May contract for delivery of this coming month closed on Friday around $20 a barrel. Overnight when trading started on Sunday evening and going into Monday, it started decreasing really rapidly and that’s because the contract was set to expire on Tuesday, which means that if you had a contract to buy oil on Tuesday, you would actually have to take delivery next month. And so normally there can be some issues with how oil traders that don’t take delivery face this contract over period, but usually you’re able to find some buyers that will take the contract off of your hands.
Alex Gilbert: What happened is that there were so many oil traders that were trying to offload their May contract because they didn’t want to take physical delivery and there weren’t any buyers. And that’s because oil demand has collapsed in the United States and abroad. Refiners are cutting runs across the country and across the world and most importantly, oil storage is filling up. And over the course of Monday, prices crashed from starting $20 on Friday to closing at negative $37 plus per barrel. That has never happened before, we’ve never had negative pricing oil, we can see an energy market sometimes but basically what happened was there was too many oil traders and not enough buyers. And the big concern is that we didn’t see at that moment the same effects for the June, July contracts meaning, there was no oil storage at Cushing that you could buy for the month of May. And we’ve been having massive growth in oil storage and this raises the prospect that we are running out of oil storage in the United States.
Jeff Schechtman: Why didn’t refineries see this coming? I mean we’ve been in this pandemic for approximately six weeks and people have been obviously driving less and there’s been less demand and for various reasons. Why didn’t refineries cut back before this last minute situation?
Alex Gilbert: Because of how the physical system works, it does take time for changes in demand and prices to filter through the system. And one of the things that is really remarkable, though it starts happening is the speed at which demand has crashed and the magnitude. We’ve never faced anything like this before. So it’s taken time for oil, for gasoline prices to go down like oil prices have. If you may have been paying attention to gas prices, you probably are not driving, they have been going down but not as quickly as oil has. And so a lot of refiners have still had margins and a lot of refiners are filling up product storage, so gasoline, diesel, jet fuel, but refiners are cutting back runs and we have seen other client in runs and that is leading to a surplus of oil production.
Alex Gilbert: The issue now is that a lot of refiners that still are doing some small amount of runs or likely already contracted, they already took a contract because they were able to find a good price. Now the big issue is that there’s just too much production on the market and producers are not able to find buyers.
Jeff Schechtman: What does this mean for future contracts? Because even as the May contracts were going into negative territory as you detail, it doesn’t necessarily mean the June, July and that going forward the same situation would materialize.
Alex Gilbert: That’s a great question. So one of the things that was striking on Monday was even though the May contract dropped $55 in that day, which is unheard of, the rest of the futures contracts from June, July being the closest to, to farther out in the curve only dropped a couple of dollars. What we’ve actually seen since then has been basic chaos for the rest of the futures curve, they have calmed down significantly. The June contract traded as low as $6 in change yesterday it’s up to about 14 or $15 now. July is hovering around $20 but the big sign that the oil market is looking at is not just the US contracts, but the global benchmark, which is Brent in Europe has also started falling down significantly. And what this is saying is that there’s a persistent concern in the oil markets that was caused by what happened on Monday with the May contract that’s now bleeding over to the other futures contracts that we don’t have enough storage.
Alex Gilbert: If we don’t have enough storage, you might not be able to sell your oil at any price, price may have to go negative and there needs to be a market signal for oil producers to stop production. Which is sometimes difficult for producers to do and sometimes they already have their production contracted out so they might not have a financial incentive to do so.
Jeff Schechtman: With respect to storage, what is the situation with regards to the US’s strategic petroleum reserves and is there room for storage there and should we be filling those at this particular time?
Alex Gilbert: That’s an excellent question. And that’s something that has been a large policy debate for the last month or so. We had sold off a portion of the Strategic Petroleum Reserve, the SPR, as part of a budget negotiation a couple of years ago. And so the SPR is not full, there’s probably around about 70 million barrels of potential storage there for the SPR. And the Trump administration has been pushing to fill that up. However, there’s a few issues. First in order to do so, they need appropriate funds from Congress during the disaster really still so far that has been a proposal but it has been rejected as part of just the political ballgames, but the department entity is also looking at other alternatives. So they’re looking at potentially contracting out the SPR as commercial storage for commercial entities. There was just a deal announced that Australia will actually use some of our SPR space to start their own reserve based here in the US.
Alex Gilbert: But there’s also a political issue that the Trump administration solicitations that ask for American made oil. Most shale oil is light oil. It’s not as, it doesn’t have as much sulfur and other things as heavier oils. Whereas what we store in the SPR is actually medium and heavy crude’s. So from an optics perspective, we actually might not be able to fill it necessarily with light crude that the US produce, might actually be imports from Mexico or even Saudi Arabia.
Jeff Schechtman: Talk a little bit about the geopolitical implications of this with respect to major oil producers beyond the United States, but Saudi Arabia and Russia specifically.
Alex Gilbert: So one of the precipitating factors in why prices dropped relatively quickly in March is that the OPEC plus group, which is the former organization of petroleum exporting countries along with other major exporters and primarily Russia, has had a deal for several years to reduce production to offset the growth in the United States. And that was to maintain oil prices at a price that those countries could support their national budget. The talks broke down in March because Russia and Saudi Arabia, they blame each other, but they have concerns that they’d been losing market share to the US and they’re not able to support prices. The cuts they were talking about then were relatively small, but because they had this disagreement, their current deal fell apart and Saudi Arabia and the UAE in particular surge oil production in March and into April. That led to exacerbating the oversupply conditions to a certain degree.
Alex Gilbert: Now because oil prices have been so low and those situations looking precarious, we did have a major deal happen between OPEC plus to restore cuts and actually increase them significantly. The top level number they’re using is 9.7 million barrels per day. There’s about a hundred million barrels per day of oil production in the world, so that is a lot, it’s something that’s never happened at that size before. But the problem is right now the coronavirus quarantines have cut demand by 20 to 30 million barrels a day. So that is increasingly being seen in the oil community as too little too late and it seems like the oil prices around the world are going to be sub $30 a barrel for most of the rest of the year. That will impact finances of oil producing countries and exporters for Russia, for Saudi Arabia, for all sorts of developing countries. And for a lot of cases that has geopolitical risks, those countries line oil revenue and in order to support their national budgets and even potentially their healthcare budgets, which is obviously not good in the middle of a pandemic.
Alex Gilbert: It is possible that we could see major instability in the Middle East and elsewhere. And that’s a concern as we move forward over the next 6 – 12 months, if those countries are not able to make up for the fall in revenue, which appears unlikely.
Jeff Schechtman: Talk a little bit about the trickle-down effect from this oil situation that we’ve been talking about, how it is affecting electricity markets, electricity producers. How it’s impacting the nuclear industry, the broader energy dynamics that change as a result of what’s happening in the oil markets.
Alex Gilbert: As an initial point, this is an indicator of what’s happening in the broader economy and the general weakness in the economy. There will be significant declines in energy demand across the board in countries besides the United States. A lot of them do use oil for electricity and other purposes. We primarily use it for transportation, so this could impact the growth of renewable energy and other resources in other countries. The United States, we expect that the primary impact on electricity markets will actually be from natural gas. So natural gas in shale production has led to natural gas becoming a substantial part of our domestic energy supply. That’s beyond just electricity, but electricity is where we see a lot of changes happening right now. And what’s happening in the oil market is important because about 16 Bcf a day of our natural gas production, which is a substantial portion, comes from what’s called associated gas production. It’s natural gas that you produce when you drill an oil well.
Alex Gilbert: So if we cut back on our oil drilling and if we also start closing some of these oil wells because oil prices are so low, natural gas production will actually fall in the US, meaning natural gas prices will go up. That said though, the coronavirus quarantines are impacting the man tests significant degree for electricity across the country. So we’re seeing electricity prices at very low numbers across the board that will impact utility revenues and in the long-term we expect that there might be an acceleration of particularly coal retirements. Coal has been on the downturn, renewables actually just passed coal generation, solar, wind and hydropower generation across the United States for the first time earlier this year. That name will be permanent if we see a large number of coal retirements. At the same time on the nuclear side, we expect that there could be some issues with nuclear plants that are struggling in certain markets because of the low prices and that could leave some retirements which would actually help boost coal in the short term and increase greenhouse gas emissions.
Jeff Schechtman: How easy is it to turn on and off the oil supply, the refinery capacity? Is that as simple as people might imagine it as simply turning a switch or is it a more complex process that takes a certain amount of lead time before even production can be ramped up again?
Alex Gilbert: So if you look at the individual parts of the oil supply chain, it’s a relatively straightforward process for each thing. So shutting in a well or reducing refinery runs or even turning off a refinery. Those are things that the businesses are prepared to do, they normally do. One of the issues that we’re seeing right now though is that we need to do it at a very large systemic level and that can cause price in physical dislocations. Now shutting in a well is not an ideal thing to do, shutting in a well cuts off production, wells are under pressure, they’re not just holes in the ground that you’re pumping things out of. It’s a lot more complex, now when you look at the geology and the concern is that when you shut in a well, you can actually damage the lifetime production with that well, so it will not produce as much oil in the future. Now things are a little bit different with shale in hydraulically fractured production in the United States. Just because we expect there might be ways to reduce the impact of a shut-in compared to other types of wells.
Alex Gilbert: But there could be large impacts on offshore production, conventional production, and also production in other countries. That by shutting these wells, we actually might see permanent declines in oil production across the world. And that’s really concerning. If you look at the situation 18 to 24 months from now, we’re going to have a lot of oil in storage, but if we see permanent damage to the oil infrastructure that produces our oil supply and we also are seeing a lack of investment in new supply right now. We could actually end up in a situation where we have the supply crunch on the outside of the current situation when we start having a recovery. And it’s possible we have oil prices reach a hundred or $150 even within two or three years. Now, that’s not necessarily likely right now. The market isn’t reflecting that, but that is a serious risk and that’s something that needs to be keep in mind as we talk about how we manage the current supply situation.
Jeff Schechtman: And renewables are certainly being impacted by this in that there was construction, there was a lot of investment happening in the renewable sector that perhaps could be on hold as a result of this.
Alex Gilbert: Yeah, so that’s something that we are seeing across the board for energy infrastructure projects is a decline in both the construction and maintenance activities. Now it’s hard to actually say what’s going to happen in the long-term for renewable energy specifically, because that’s going to be highly dependent on policy and what happens with any stimulus resulting from the current situation. In the short term though, we do see that there is decline in construction. There are some layoffs occurring in the industry and this is particularly a concern with certain segments of say the solar industry that look at commercial industrial consumers. If you’re a commercial and industrial consumer right now that was thinking about going solar, the current situation is probably going to lead you to delay or even cancel your order or your plan just because of the uncertainty involved. Utilities, is going to be a little bit different, but in general this is something that could delay or pause the sector for a little while as we go through the market and policy uncertainty.
Jeff Schechtman: The other aspect of this, which is somewhat ironic, particularly with regard to what you were just saying with respect to renewables, is that there’s environmental improvement that a lot of people are seeing as a result of what we’re dealing with right now. And there’s going to be a certain push from the environmental community to respond to this in some ways.
Alex Gilbert: Yeah, so that’s one of the things that is most striking to, I think, many members of the public but also many members of the environmental community, is how quickly the impacts on the energy system have led to air pollution reductions and increases in air quality. There’s images from all around the world of certain areas where you can see for miles that you normally don’t see before, in California, in the LA basin is a good example. There’s pictures coming from India where people can see the Himalayas hundreds of miles away but they haven’t seen for 30 some odd years. This is not necessarily a good sign from an economic perspective, this is just reflecting the fact there’s no economic activity in a lot of these areas. It is good short term science from a public health perspective because this does reduce the public health impacts on people.
Alex Gilbert: We’re seeing declines in certain types of air pollution, illnesses, particularly asthma hospital admissions. And that said though, when we start having the recovery, those benefits and those reductions are probably going to largely disappear. The way that I would describe it is that this is really a vision of the future that we could have in 2050 if we really work on cleaning up our energy supply system. If we really try and make sure that we can make these air pollution reductions permanent. It’s going to take a lot of work and effort to get there, but this is a vision of the future that we could have better health, more beautiful views and generally a more fair economic system.
Jeff Schechtman: Would you have expected the system overall, internationally, globally, to be more resilient and more reliable in the face of this kind of a black-swan-like event, or is this what those that look at this, people that do what you do might have expected at this point?
Alex Gilbert: Oh, that’s a good question. What I would say is that short of a significant international conflict, the magnitude and the rapid pace at which these impacts have occurred is largely unexpected. There is a certain amount of energy resilience baked into energy systems across the world. One thing I will say is that it does sound strange, but electricity systems have actually handled the decline in demand really well. Normally we care only about ensuring there’s enough supply because that’s the main resilience issue, but there are demand reduction issues that can happen on the resilience side. And so far we’ve not seen any major allergies resulting from that, we’ve not seen any major systems damage, so that has been a relative bright spot and just knowing that at least in a severe situation like this, electricity is doing well. On the oil side, I think that this has been a complete shock for the industry because the speed at which it’s happened is much quicker than the oil industry can normally respond.
Alex Gilbert: If this had occurred over the course of a year or so, things would be really intense, they would be tough, but the oil industry might be able to figure out ways to reduce oil production, to build more storage, to manage all the impacts that we’re seeing right now in a way that doesn’t cause as severe economic impacts. That said, right now what we’re seeing, we’re actually getting at a point that we have too much oil, we’re not going to have enough storage. We could see physical damage or other issues to the system unless we take some dramatic action and it’s not clear if we’re necessarily on the path to do that. So the financial fall off that is going to be unprecedented. There’s a handful of companies and countries around the world that hedge their oil production at higher prices and so they’ll be resistant.
Alex Gilbert: A good example is Mexico, which has done a very good job over the last 15 years or so of hedging oil production to protect against these types of events, but generally speaking, this is something that is truly is a blast one event, and it’s something that will be an oil shock that will define the system moving forward.
Jeff Schechtman: From what you’ve seen thus far, what are the lessons that the industry and the system might take away from this?
Alex Gilbert: I think that there will be a major fallout in the short term on financing and how the financial side of oil works. In the US particularly, we’ve seen that shale has been supported by relatively easy money and financing for the last 8 or 10 years or so. And generally the financial conditions for most of these oil companies have not expected lowest profits or even significant dividends except for the oil majors. Rather, it’s been an expectation of keep growing your company, keep producing more oil and we’ll make money down the road. I think that this has really shattered expectations that we can just keep growing oil indefinitely within the financial community and moving forward it’s going to be a lot harder for oil and gas companies, particularly in the United States to raise money. More broadly, I think this is going to raise a lot of questions about how our global oil infrastructure is ready to handle not just supply shocks, but supply and demand shocks.
Alex Gilbert: There could be a push to build a lot more oil storage. That could be an effective medium term way to address some of these issues, but there’s also going to be a larger discussion about how do we price handle and contract crude oil. How do we also handle the international trade aspects? This situation more than anything I think underscores that while oil used to be dominated by OPEC and their control and use of a cartel for the oil market, they have winning power to control prices and production from now on. They definitely still do and they do along with Russia have an ability to affect things on the margin, but the United States is now in many cases the swing oil producer for the world and that is something that was completely different 10 years ago. The US has some of the highest oil production, the highest oil demand, and the most midstream refiners over any country in the world. We’re increasingly becoming the Keystone for the oil market and so this really raises a lot of questions about how do we manage this going forward?
Alex Gilbert: Ideas of energy independence, I think have been quashed. There’s no such thing as energy independence in an interdependent market like we have. This is something that oil price impacts in Europe and Asia will impact our economy and our energy markets here as well.
Jeff Schechtman: In that sense has this democratized the oil markets?
Alex Gilbert: I wouldn’t necessarily say democratize but it has reduced the power of the cartel. And it has definitely led to the use of more market-based mechanisms, like the US prefers, that we believe generally lead to the best economic outcomes and we think is the most fair. The issue that I would have a reservation on there is just in terms of the idea of having as many people participating in the oil markets might not actually be true after all this is well and done. The largest financial impacts within the United States of the current situation are going to be on small and medium oil producers. A lot of them are going to go bankrupt. All of them are going to be acquired. The major companies are likely going to be able to survive this without major impacts. But a lot of, “Mom-and-Pop shops” across oil-producing states in this country are going out of business. So this is a situation where we actually see a lot more consolidation within our own industry to a smaller number of firms.
Jeff Schechtman: Alex Gilbert, I thank you so much for spending time with us today here on the WhoWhatWhy Podcast.
Alex Gilbert: Thank you.
Jeff Schechtman: And thank you for listening and for joining us here on radio WhoWhatWhy. I hope you join us next week for another radio WhoWhatWhy Podcast. I’m Jeff Schechtman. If you liked this podcast, please feel free to share and help others find it by rating and reviewing it on iTunes. You can also support this podcast and all the work we do by going to whowhatwhy.org/donate.

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