Dark Days for Oil Companies

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Covid-19 has wrought widespread economic devastation, but the oil sector has been hit particularly hard. This is reflected in the oil price of $29 (as of this writing), lower than it’s been since 2002.

Before discussing all the ways Covid has harmed the US oil sector, I will provide some background on where the state of the sector heading into the crisis. On the surface, oil and gas was thriving. Thanks to the fracking boom the US has become the world’s top producer of both crude oil and natural gas, and production in 2020 was forecast to be the highest on record. But the headline figures concealed a financial rot that had set in. After the oil price crash in 2014, banks and investors that were still bullish on fracking came to the rescue with a huge volume of medium-term loans. The bulk of those loans were coming due in the next few years, but many oil companies were still in poor financial health, and many defaults and business closures were expected (in fact, over 200 fracking companies have already gone bankrupt since 2015). Oil and gas prices had remained stubbornly low due to the increasingly fierce competition from renewable energy sources and the rise of electric cars. Investors have caught on to sector’s poor prospects, as energy stocks have badly underperformed the rest of the market since 2015. An analysis by consultancy Rystad Energy said that at prevailing prices, almost all new fracking wells would lose money. Again, this is all before anyone had heard of Covid-19.

The pandemic has now laid waste to the oil sector. Global air traffic is down by 75-80%, and US gasoline demand is down by around 50% as a huge portion of the workforce is working from home. The cruise industry, which uses staggering amounts of fuel, has all but shut down (note that the natural gas sector, which is mainly used for electricity, has not been harmed as badly as electricity demand is only down slightly, while oil is used almost exclusively for transportation). Oil revenues are projected to be a full trillion dollars less in 2020 than 2019, and the sector has lost roughly 45% of it’s already depressed stock market value since the pandemic began.

A bizarre outcome of the industry’s troubles came on May 20th when the WTI crude price spent most of the day in negative territory, going as low as -$37. Due to the collapse in oil demand, America’s oil storage capacity had all but run out. The WTI price is actually the value of a futures contract, where the holder of the contract is legally obligated to accept delivery of barrels of oil in Cushing, Oklahoma on the 20th of the month (note that the usual price you hear about in the news is the Brent Crude Index, which is more representative of the global market. The WTI is a US-specific grade of oil). Thanks to the lack of storage, producers would actually pay anyone who was willing to take the product off their hands. The negative price was therefore somewhat of a quirk in how the futures market works, but it is still a sign of how precarious the sector is right now.

The immediate outlook for oil companies is grim. Even as lockdowns around the world are winding down, tourism will not bounce back for the foreseeable future, and many will continue to work from home. However, an eventual rebound in demand combined with the lack of new production during the pandemic could cause prices to rally. The federal government is likely to provide major assistance to the sector, and the production cuts agreed between Saudi Arabia and Russia will eventually ease the global glut of over-production. But the next 1-2 years is going to see a lot of energy company closures, and the cost of renewables continues to decrease. The pandemic may simply accelerate the long-run decline of fossil fuels.

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Brock Smith is an Assistant Professor in the Department of Agricultural Economics and Economics at Montana State University. He received a PhD from UC-Davis in 2013 and spent three years as a Research Fellow at the Oxford Centre for Analysis of Resource Rich Economies. He mainly studies effects of oil and natural gas shocks in both an international and domestic US setting.

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