Demand Drop: The Latest in the Oil Price War
It’s clear that the world has changed due to COVID-19. We are in uncharted territory on so many levels.
Last Thursday, jobless claims shot up 33% from the prior week to 281,000. But that will likely be just the tip of the iceberg.
Goldman Sachs is predicting we’ll see 2.25 million jobless claims in this week’s report.
And some economists are predicting unemployment could hit 10% or more. We haven’t had that many people (about 16.5 million) out of work since the Great Recession.
The virus is also having a big impact on the oil sector. Last Wednesday, oil prices dropped to 18-year lows.
But oil isn’t suffering just from the drop in demand due to the coronavirus. Russia and Saudi Arabia are in the middle of a full-on price war.
Too Much Oil
Saudi Arabia became increasingly frustrated with Russia’s unwillingness to negotiate production cuts. So it decided to ramp up production and flood the world with an additional 2 million barrels per day (bpd) that it doesn’t need.
It plans to send nearly 12 million barrels to American Gulf Coast refineries. We could end up with the biggest crude surplus in history.
So there’s a ridiculous amount of oversupply. Plus, there’s a simultaneous coronavirus-triggered demand destruction.
Estimates are that China’s daily use could drop by 20% or more. China is the world’s second-largest user, at 12.8 million bpd.
If the 20% cut holds true, that’s 2.5 million bpd China won’t need to import.
What about the U.S.?
The U.S. is the world’s largest crude consumer, guzzling about 19.33 million bpd in 2019. An accurate estimate on the shrinking demand is difficult to obtain.
California alone uses about 10% of U.S. crude. With California in lockdown mode, demand is going to plummet.
The Bottom Line
I think we could see a global demand drop of 10 million to 20 million bpd. That degree of demand destruction would be unprecedented.
One of the biggest problems we have is where to put the surplus oil. President Trump wants to top off America’s Strategic Petroleum Reserve.
That purchase will take care of 77 million barrels. The reserve can receive about 685,000 bpd.
But if my prediction holds true, filling the reserve won’t reduce oversupply by nearly enough. I think we’re going to see many small- and medium-sized U.S. shale producers go bankrupt very quickly.
Most of the U.S. shale producers don’t have positive cash flow. If prices reach as low as $5 per barrel, these shale producers will soon drop like flies.
To fix this, the U.S., Russia and Saudi Arabia will all have to agree to cut production. If all three agree to matching cuts, that will take nearly 4 million bpd offline.
I believe we need to see WTI crude at $50 per barrel for these companies to hit positive cash flow. We likely won’t see that price until 2021 at the earliest.
If you have any investments in the oil patch – especially in small and midsized producers – now is the time to get out, if you haven’t already done so.
Stay safe and healthy,
Dave
