The urgent message of negative oil prices

[FireLane]

The oil markets have been on a wild ride. First, a price war between Russia and Saudi Arabia flooded the market with crude; then an overnight global lockdown cut demand to near-zero just when supply was at its peak. This week, for the first time ever, a benchmark oil price briefly turned negative:

In other words, because it costs money to store and transport oil, drillers—and, specifically in this case, those of West Texas Intermediate Crude—are now having to pay pipeline and storage companies to take product off their hands, as space for storing excess oil runs out fast. This might be the greatest crisis to face the oil industry since there’s been an oil industry, and no one in power seems to have a plan for what to do about it.

The article points out that American energy companies are heavily over-leveraged and loaded down with debt. This is going to be disastrous for them. One industry report predicted that one million oil workers could be laid off this year.

The implications of that will reverberate well beyond job sites and show just how wide-reaching a just transition from fossil fuels will need to be in a society that’s been built around them. From individuals to trillion-plus-dollar pension funds, many have become investors in fossil fuels and other polluting industries through the massive rise of passive investment funds, housed in products offered by giant asset managers like Blackrock, Vanguard, and State Street. Millions of retirees and union members are now unwitting fossil fuel financiers, exposed to the risk of that industry going bust. In states with high levels of fossil fuel extraction, public budgets for things like education and public services are tied up in a presumed tax base created by the well-paying jobs those industries offer. That’s particularly true in states where Republican legislatures and governors taking mountains of fossil fuel donations have offered generous tax giveaways for drillers, letting them siphon profits out of state instead of capturing them for the long haul. This problem is more pronounced still for low- and middle-income oil producers like Nigeria, Iraq, and Algeria, where revenue from oil exports accounts for huge chunks of national budgets.

As someone with a big chunk of money in passive funds, I felt the punch of that line about "unwitting fossil fuel financiers". I don't want to fund my retirement with money that was made by ravaging the planet, but if you invest in index funds, it's unavoidable. Not just the oil and gas companies, but the car companies, the airlines and everything else that runs on dirty fossil fuel.

On the other hand, it's nice to be in a position of strength and to know that I don't depend on that dirty money, as so many others do. With a broadly diversified investing position, fossil fuels are just a small part of my portfolio. If these drilling and extracting companies go out of business, new companies, hopefully better and greener ones, will rise to replace them. And if this crisis is the catalyst for rethinking our collective dependence on fossil fuels, so much the better.

[JetBlast]

Uhh... so what’s the urgent message?  That a bunch of over leveraged drillers are going to go bankrupt?

[seattlecyclone]

Sounds like a great time to adopt a carbon tax.

As to the negative prices, I'm curious what causes the companies to find it more palatable to pay people to take their oil than to simply set it on fire or something.

[maizefolk]

Sounds like a great time to adopt a carbon tax.

Agreed.

As to the negative prices, I'm curious what causes the companies to find it more palatable to pay people to take their oil than to simply set it on fire or something.

Probably environmental regulations against doing so.

Plus my guess is that a lot of the folks who ere selling oil futures for negative prices on Monday were futures traders with no infrastructure to actually receive (let alone burn) the oil they'd purchased the contractual obligation to receive.

[raincoast]

Some of the over-leveraged companies will go bankrupt. Stronger ones will survive. When the lockdowns end demand for oil will increase, though it will take a while to return to pre-pandemic levels - possibly years, possibly never if the right environmental measures are put in place. Stronger companies will buy many of the assets of the bankrupt companies and hire many of their employees. If demand and prices remain low, companies will likely shut down lower margin wells/sources (bad news for the Alberta oil sands), so some employees will be out of work for the long term and will likely find new career paths.

But the industry as a whole will survive, because oil and the infrastructure, equipment and skills needed to extract it, refine it, and transport it to market will still be needed until the world fully transitions to renewable energy.

@seattlecyclone is right - this is a great time to adopt an aggressive carbon tax. It will be politically easier to keep demand at a post-pandemic low than to try to push it down again after demand rebounds.

[LWYRUP]

In an ideal world a bailout and a carbon tax would be connected together so there's not a big political fight.  But I'm not hopeful. 

There'll be bailouts now and then fights to the death about taxes later.

[BECABECA]

I had become more and more uneasy with having oil companies in my index funds, especially as more and more institutional investors have been divesting from them every year. Last year I moved my retirement accounts out of VTSAX and into VFTAX, the equivalent ESG index fund. But I hadn’t moved my taxable accounts out of VTSAX since it would incur a big taxable event. When the market hit the low point in March, I was able to tax loss harvest everything out of VTSAX and into VFTAX. So now I don’t have to worry so much about when oil is going to fall off a cliff.

[maizefolk]

Last year I moved my retirement accounts out of VTSAX and into VFTAX, the equivalent ESG index fund.

Are you sure these are equivalent funds?

VTSAX is invested in 3535 companies. VFTAX in only 480.

Or are less than 14% of companies in VTSAX considered ethical what the standards of whoever put together the index VFTAX tracks?

[Paul der Krake]

Oil prices aren't negative, they're just very low.

A subset of oil short dated futures contracts are negative because it comes with the rather difficult obligation to take delivery of it almost right away and everyone is just kinda busy with other shit right now.

Details matter.

[marty998]

Last year I moved my retirement accounts out of VTSAX and into VFTAX, the equivalent ESG index fund.

Are you sure these are equivalent funds?

VTSAX is invested in 3535 companies. VFTAX in only 480.

Or are less than 14% of companies in VTSAX considered ethical what the standards of whoever put together the index VFTAX tracks?

Maybe it's just that 6 in 7 of companies in your index fail on ESG :)

Perhaps if most of the big ones are still in there then you still get similar performance.

[beltim]

Oil prices aren't negative, they're just very low.

A subset of oil short dated futures contracts are negative because it comes with the rather difficult obligation to take delivery of it almost right away and everyone is just kinda busy with other shit right now.

Details matter.

This.  Details matter, because the conclusions in the original post are mind-bogglingly factually wrong.  Specifically this, which is a bald-faced lie:

In other words, because it costs money to store and transport oil, drillers—and, specifically in this case, those of West Texas Intermediate Crude—are now having to pay pipeline and storage companies to take product off their hands, as space for storing excess oil runs out fast.

No drillers pay people to take oil off their hands.

[HenryDavid]

For me the "urgent message" here is that oil addiction, like other kinds, eventually leads to completely insane behaviour.
Here in Canada, an oil-addicted place for sure, we have both a carbon tax and massive taxpayer-funded oil company bailouts.
The carbon tax is kind of sensible: I just got a big refund on my income tax, to offset the excess carbon tax I paid in 2019--if I had a higher taxable income I'd pay more carbon tax. It's built into any kind of consumption. Just like oil is built into all products, food etc. even if just for transport.

But here's how insane oil makes you: to solve the storage problem in Canada, governments are proposing . . .  underground storage!
Huh. You pump it out of the ground. You find nobody wants it. Which you should have already known, but anyway. So you pump it back under the ground, only someplace else.
Definition of insanity.
Yet within the narrow terms that apply in an office someplace, I bet it makes a kind of (very short-term) sense.

[maizefolk]

For me the "urgent message" here is that oil addiction, like other kinds, eventually leads to completely insane behaviour.
Here in Canada, an oil-addicted place for sure, we have both a carbon tax and massive taxpayer-funded oil company bailouts.
The carbon tax is kind of sensible: I just got a big refund on my income tax, to offset the excess carbon tax I paid in 2019--if I had a higher taxable income I'd pay more carbon tax. It's built into any kind of consumption. Just like oil is built into all products, food etc. even if just for transport.

But here's how insane oil makes you: to solve the storage problem in Canada, governments are proposing . . .  underground storage!
Huh. You pump it out of the ground. You find nobody wants it. Which you should have already known, but anyway. So you pump it back under the ground, only someplace else.
Definition of insanity.
Yet within the narrow terms that apply in an office someplace, I bet it makes a kind of (very short-term) sense.

I am so jealous of Canada's carbon tax. Does everyone get a fixed carbon tax refund or does it scale with income? (I'd argue for the first but would be happy with either of the two).

The US Strategic Petroleum reserve is basically just a bunch of underground storage. I think it's crazy we're not buying oil to fill it up while prices are this low. But that's a bunch of oil we're already supposed to have underground for other (strategic presumably) reasons, not just storing it for the heck of it.

[LWYRUP]

For me the "urgent message" here is that oil addiction, like other kinds, eventually leads to completely insane behaviour.
Here in Canada, an oil-addicted place for sure, we have both a carbon tax and massive taxpayer-funded oil company bailouts.
The carbon tax is kind of sensible: I just got a big refund on my income tax, to offset the excess carbon tax I paid in 2019--if I had a higher taxable income I'd pay more carbon tax. It's built into any kind of consumption. Just like oil is built into all products, food etc. even if just for transport.

But here's how insane oil makes you: to solve the storage problem in Canada, governments are proposing . . .  underground storage!
Huh. You pump it out of the ground. You find nobody wants it. Which you should have already known, but anyway. So you pump it back under the ground, only someplace else.
Definition of insanity.
Yet within the narrow terms that apply in an office someplace, I bet it makes a kind of (very short-term) sense.

I am so jealous of Canada's carbon tax. Does everyone get a fixed carbon tax refund or does it scale with income? (I'd argue for the first but would be happy with either of the two).

The US Strategic Petroleum reserve is basically just a bunch of underground storage. I think it's crazy we're not buying oil to fill it up while prices are this low. But that's a bunch of oil we're already supposed to have underground for other (strategic presumably) reasons, not just storing it for the heck of it.

We are filling up the reserve.

[maizefolk]

The US Strategic Petroleum reserve is basically just a bunch of underground storage. I think it's crazy we're not buying oil to fill it up while prices are this low. But that's a bunch of oil we're already supposed to have underground for other (strategic presumably) reasons, not just storing it for the heck of it.

We are filling up the reserve.

We are?

You may well have more up to date info on this than I do. What I'd read up till now is that filling the reserve was proposed as part of the most recent stimulus bill, but not ultimately included in the bill, and then more recently Trump proposed buying more oil for the reserve but said he'd need congress to sign off on it, which they hadn't yet.

[LWYRUP]

The US Strategic Petroleum reserve is basically just a bunch of underground storage. I think it's crazy we're not buying oil to fill it up while prices are this low. But that's a bunch of oil we're already supposed to have underground for other (strategic presumably) reasons, not just storing it for the heck of it.

We are filling up the reserve.

We are?

You may well have more up to date info on this than I do. What I'd read up till now is that filling the reserve was proposed as part of the most recent stimulus bill, but not ultimately included in the bill, and then more recently Trump proposed buying more oil for the reserve but said he'd need congress to sign off on it, which they hadn't yet.

Nevermind, you are ahead of me.  I think I got lost at "proposed at stimulus bill" and didn't realize it didn't get through.

[partgypsy]

What is the shelf life of gas? I thought it could not be stored indefinitely. Which would limit the benefit of "strategic" reserves.

[LWYRUP]

What is the shelf life of gas? I thought it could not be stored indefinitely. Which would limit the benefit of "strategic" reserves.

For residential storage of gas, you need fuel stabilizer and that gets you a year.  But remember gas is processed from Oil.  Oil can be stored long term but I don't know the precise scientific details.

[BECABECA]

Last year I moved my retirement accounts out of VTSAX and into VFTAX, the equivalent ESG index fund.

Are you sure these are equivalent funds?

VTSAX is invested in 3535 companies. VFTAX in only 480.

Or are less than 14% of companies in VTSAX considered ethical what the standards of whoever put together the index VFTAX tracks?

VFTAX is basically only large cap US companies that meet ESG criteria. They exclude small cap companies since it’d take a lot of overhead to assess thousands of small cap companies and that work has diminishing returns given that the smaller the company, the smaller proportion it is of the fund. 80% of VTSAX is S&P 500, so it’s equivalent enough for me.

[FireLane]

Uhh... so what’s the urgent message?  That a bunch of over leveraged drillers are going to go bankrupt?

The message, I assume, is that many states and countries are unwisely basing their budgets on a commodity that's subject to dramatic price swings.

Details matter, because the conclusions in the original post are mind-bogglingly factually wrong.  Specifically this, which is a bald-faced lie:

In other words, because it costs money to store and transport oil, drillers—and, specifically in this case, those of West Texas Intermediate Crude—are now having to pay pipeline and storage companies to take product off their hands, as space for storing excess oil runs out fast.

No drillers pay people to take oil off their hands.

I don't know if we're already at the point of oil producers paying people to take their oil away, but the idea isn't absurd, much less "a bald-faced lie". An oil well isn't like a faucet, you can't just turn it off without risking permanent damage to the installation. When prices are very low, it's possible that some drillers will decide to keep pumping at a loss and hope that prices will improve before they go bankrupt. See here:

When demand plummets and prices drop, it takes time for oil producers to start turning off existing wells. Reducing output like that is known as "shutting in" production.

"Shutting-in production is a very painful decision for an operator to make," Teodora Cowie, an analyst with Rystad Energy, writes. "Often the economics support running a well at a loss for a certain period of time rather than shutting down the project completely."

As long as prices are greater than zero (an unusual disclaimer for these unusual times), a well will still bring in some money. And oil companies have fixed costs they have to cover. Even if they're taking a loss overall, it may be better to keep a well running than to bring in no money.

They're also looking ahead to the future, when demand and prices are eventually expected to rebound. An oil well is not like a light switch you can flick on and off. A well that has been shut down can be hard to turn back on.

Elizabeth Gerbel, CEO of EAG Services, an oil and gas consulting company, compares it to a bottle of soda. If you put the cap back on and store it in the fridge for a while, it will never be as bubbly as when you first cracked it open.

Similarly, if you start pumping from a well, shut it down and try to get it running again, "it is almost guaranteed you will have to invest more money in the well to get it to produce at the same level," she says.

And it's not just the physics of oil fields working against producers here. It's their legal contracts: They may have signed leases that require them to drill the land in question. "If you are forced to shut-in a lot, you technically can lose your lease to a competitor," Gerbel says. "And then you're going to have to buy them back."

So even at very low oil prices — prices where oil producers clearly are unable to make a profit — they might opt to keep wells running now, to ensure they can operate those wells in the future.

[maizefolk]

What is the shelf life of gas? I thought it could not be stored indefinitely. Which would limit the benefit of "strategic" reserves.

For residential storage of gas, you need fuel stabilizer and that gets you a year.  But remember gas is processed from Oil.  Oil can be stored long term but I don't know the precise scientific details.

Yup. Crude oil has existed as crude oil underground for millions of years already, so nothing bad happens to from being stored for a few years or decades. The strategic reserves are just big caves full of oil which can be cheaply and easily pumped back out to keep US refineries running for a while, at somewhat reduced capacity, and producing gasoline even if the USA lost access to overseas sources of oil that are currently imported into the country.

For example an oil embargo or a non-nuclear world war III. A nuclear world war III would be over fast enough that I don't think any survivors would have time to worry about where their gas was coming from.

The wikipedia article for the SPR currently has this delightful bit of I'm-not-sure-it's-even-technically-vandalism in the first paragraph.

At recent market prices ($-37 a barrel as of April 2020),[5] the SPR holds over $-9.26 billion in sweet crude and approximately $-20.4 billion in sour crude (assuming a $15/barrel discount for sulfur content).

[zolotiyeruki]

I guess I'm not seeing any big lesson other than "don't start a price war during a budding pandemic when the market is already saturated."

Some of the oil companies that are over-leveraged may go bankrupt.  Their assets will get repossessed and resold, presumably at a discount, to new owners who will continue to produce the oil.  Or, they're pre-negotiate some sort of bankruptcy deal to write down some of the debt, and continue operations with a lower debt load.

I struggle to follow the logic that because the oil industry got hit with by a one-two punch, the world should abandon petroleum.  It'd be akin to abandoning agriculture during the Dust Bowl.  That train of thought is stunningly illogical, as is the thought of "this is a great time to institute a carbon tax."  Instituting a big ol' tax hike right when 22 million people have lost their jobs doesn't seem particularly wise.

FWIW, the US has been a net exporter of all petroleum products since some time in November 2019, and of natural gas since some time before that.  That's one major why all the recent kerfuffles in the middle east haven't moved the needle on oil prices very much, and that new supply is a big reason why Russia started the price war.

@FireLane producing oil at a loss is different from paying someone to take it off your hands.  The article you linked explains why producers may still pump oil at low (positive) prices, because even at those low prices, they can offset some or all of their fixed costs.  Why would they ever spend the money to produce the oil, and then pay someone to take it off their hands?

As for states and countries basing their budgets on a volatile commodity, other than OPEC and a few other areas, who would that be?

One more thought: Even if you divest from petroleum companies in your portfolio, the entire world relies on petroleum in some way, whether it be for energy or as raw materials for plastics and other chemicals.  So even if your ESG index fund doesn't include oil companies, pretty much everything else on the list relies on them.

[LWYRUP]

@zolotiyeruki, I agree with your description of the bankruptcy process.  The justification for the price war I heard on the news was "Russia wanted to break the US shale industry."  That didn't make any sense to me.  So the current owners all go bankrupt.  Sucks for them.  Someone else will buy the assets out of bankruptcy and we'll be back to business once prices rise.  And if the new owners don't understand shale, they'll hire the old owners as consultants to help them.  I don't understand the logic -- either it's people from command economies not fully appreciating capitalism, or it's just made up reasoning.

I do think a carbon tax would be easier to implement when prices are low.  It will mean less of an impact on the end user because low prices and taxes will offset.  And we need to pay for the bailouts some way, so this is one of the ways to do it. 

Personally, I just use VTSAX and don't bother with "ethical portfolio" stuff.  All depends on your definition of ethical.  I'd rather own Kinder Morgan (pipeline company) than Facebook.  And I'd rather own a gun manufacturer than someone that produces junk food like McDonalds or unnecessary plastic junk from China.  Or someone that makes alcohol over a credit card company.  But everyone's got their own view of these things. 

[BudgetSlasher]

As to the negative prices, I'm curious what causes the companies to find it more palatable to pay people to take their oil than to simply set it on fire or something.

On the production side, probably, because it cost a significant amount of money to shut down, moth ball, and reopen a drilling operation. Thus a company might choose a short period of losses over the cost of a shut down.

On the market side of things, there are wall street people who buy the rights for a future delivery with the intent of reselling it later at a higher price. But if the delivery date comes and they still have the contract they have to accept delivery ... and there are no oil storage facilities on wall street.

[kpd905]

The administration has planned to roll back fuel economy standards, remove methane leak standards from oil + gas companies, rollback regulations under the Clean Air Act, replaced the Clean Power Plan which would promote sustainable energy, removed regulations under the Clean Water Act, downsized protected land to allow for mining and drilling for oil and gas, proposed increasing the allowable levels of a herbicide known to cause premature births, and scaling back the requirements for storing waste from coal-fired power plants.

What is the chance that they propose a Carbon tax?

[elysianfields]

Anyone else here shorting debt-laden oil or gas companies like CHK?

[ice_beard]

Even heavily leveraged oil cos are up considerably the past few days with a bit of a rebound in the price of crude.  If you want to make money on low oil prices, just buy oil company stocks.  Better yet, have bought them a week or two ago. 

For OG analysts, it's no secret who is facing bankruptcy.  They know how valuable a companies wells are at all price points and they know how much debt a company has and when it is due.  Sure a few companies have declared bankruptcy and some more probably will too.  But those are about the equivalent of one or two McDonalds closing in the entire US.  Would you really notice it as a consumer of McDonalds?  Not really.  (Okay, something like OXY going under would be like Georgia losing all its McDonalds, kind of a big deal, but Wendy's is just going to buy all those stores and turn them into Wendys now). 

The really big impact of the low prices are loss of oilfield services jobs.  These are good paying, blue collar jobs that are just evaporating all over the country.  They will come back when shut in wells are profitable again but no one really knows when that will be. 

Those negative oil prices were a function of a whole lot of people (retail investors) getting involved in oil futures who actually had no idea they were buying futures contracts.  USO is a huge futures contract ETF and billions of dollars poured in when prices tanked.  People thought they were getting something like XLE, a broad Oil/Gas ETF, when they weren't, they were getting sold futures contracts in a market where no one was interested in buying.  When those were about to expire (they have to be sold by a specific date) office people and retail investors had to essentially pay people to take their oil otherwise they would have to physically take possession of their contracts.  The next day, the last day of the contract period, prices were back to positive, something like $10. 
 
Yes, supply is up and demand is way down, so the price is low.  Alas, the end of oil is not nigh.