BY GUOWEI (GARY) LI
From “water is more expensive than oil” to “spend money on oil,” U.S. oil prices experienced a historic plunge, dropping as much as minus $40.31 a barrel on Monday and closing down about 305% at -$37.63 a barrel.
What does that mean? For example, if a buyer of crude oil approaches a seller of crude oil at Monday’s prices, the seller would owe the buyer $40.31 for each barrel the buyer purchases. The irony of “you buy my stuff, I’ll have to give you your money” has been born in the world’s largest commodity futures market.
So how did this come about? On April 15, a CME clearing house issued a test announcement, saying if there is a zero or negative price, all CME trading and clearing systems will continue to operate normally, all regular trading and position processing can be executed in the clearing, that is, the test preparation has been completed.
In other words, just a few days before Monday, the Chicago Board of Trade completed the zero price and negative price test of oil, thus the exchange system turned on the negative price “switch” of trading contracts. Oil plunged to -$40 a barrel.
The historic event, if analyzed from a single perspective, seems to have its logic, but it is not complete. The analysis should be multi-level and multi-perspective.
Edward Cross, president of the Kansas Independent Oil & Gas Association, said Kansas oil prices are also suffering.
“Oil prices have plunged in recent days,” Cross said. “On Tuesday, Kansas’ posted price was 25 cents per barrel before rebounding to $4 per barrel (Wednesday). The problem comes down to a lack of crude oil storage capacity, crude oil demand destruction in the wake of COVID-19-related lockdowns and concurrent crude oil supply shock created by Saudi Arabia and Russia, who were trying to make a play for global market share with each attempting to gain at the expense of the other and at the expense of the U.S.”
The drop in oil prices could also lead to repercussions for those who work in the industry. According to Cross, jobs are no longer safe amid the current financial situation.
“You could see huge layoffs and bankruptcies in the industry,” Cross said. “Demand destruction from the COVID-19 pandemic was already going to destroy an estimated 20 (million) to 25 million barrels of demand. It’s a situation that could tank not just the state oil industry, but the national industry as well, with serious repercussions for the Kansas economy — and state budget shortfalls that some predict will be worse than anticipated.”
According to Dr. Yang Jiao, assistant professor of economics at Fort Hays State University, Monday’s historic low for oil prices was a day that will long be remembered in the industry.
“It was one of the most epochal days in the history of oil trading, which is saying something,” Jiao said. “I agreed with the opinions of Ryan Sitton, commissioner at the Texas Railroad Commission: ‘It’s the worst oil price in history, which shouldn’t be surprising because it’s the inevitable result of the biggest supply and demand disparity in history.’ ”
Cross went on to say the collapse of the Kansas petroleum industry could cost state and local governments more than $1.4 billion in tax revenue annually, and more than 118,000 jobs and $3 billion in family income could be affected — which were numbers calculated even before the current price crash.
“The petroleum industry nationwide supports more than 10 million jobs,” Cross said. “For Kansas producers, this is devastating. It’s below the cost to produce. So you’re going to start seeing a lot of shutting down. Unless demand returns quickly and prices recover, layoffs among Kansas producers, which are predominantly small businesses, are inevitable. Most of the small producers have probably applied for the federal PPP loans, which could keep them in business for eight to 10 weeks, but after that — barring further federal intervention — companies will simply have to let people go.”
Jiao said the declining prices are not surprising to economists, especially from the demand side due to efforts to limit the spread of coronavirus affecting air travel and people working from home and not driving as much.
“It is also worth noting the elasticity of oil supply product is very low, meaning the price of crude oil is very sensitive to the consumer’s demand and a very small change in the demand leads to a large drop in the supply,” Jiao said. “The lack of elasticity in the supply and the lower demand due to pandemic both accounts for the historical low oil price in the market. But I think the oil price will go up as the demand goes up, but the question is when. I also think it would be more insightful to examine the impact of lower oil prices on the oil industry, to the workers who are employed in the oil industry and to the customers as a whole.”
Cross has similar thoughts regarding how to increase demand — getting people back to work.
“The longer this goes on, the deeper you dig the hole, the harder it is to crawl out. The solution for our industry and everybody is you’ve got to get people back to work,” Cross said. “Most people associate oil with gasoline. However, petroleum is used for far more than just fuel. There are more than 6,000 products produced from petroleum which, like soap and plastic, contribute to comforts we all enjoy.”
Once demand and prices return to normal, Cross said several things should be considered to help the Kansas oil and gas industry, none of which involve bailouts.
“We need to find solutions to high Kansas electric rates — which hurt not just the oil industry, but general economic development as well,” Cross said. “Kansas rates are the highest in our region, and Kansas consumers spend more than $1 billion per year more on electricity than just 10 years ago. With electric costs that are 30% to 50% of expenses, oil wells in rural Kansas could run for many years longer with more competitive electricity prices. Who will be left to absorb the high fixed costs that burden rates? Oklahoma rates can be more than 50% less than in Kansas.
“Renewable energy sources like wind need to be carefully considered going forward. The state has adequate renewable energy generation, and careful study is required before allowing more subsidies. Methane and carbon dioxide emissions are significantly down in the U.S., even as oil and gas production has dramatically increased. We must resist unduly penalizing and regulating the fossil fuel industry for political expedience. The oil industry will be back up and running in the medium-term — the next couple of years. I think there’s a turnaround coming once demand returns and the market supply gets balanced.”
Before Monday’s market crash, Cross authored a report on the dynamics of the oil market. The report provides a detailed summary of the oil market, including the direction of policy and how oil prices got here, what the impact is and what the future impact will be. The report was shared with the White House as well as the Kansas congressional delegation.