On April 20th, 2020 May contracts for WTI Crude Oil dropped below $0.00/barrel for the first time in history and were trading as low as -$40.32 at the time this was written. What does it mean that prices have dropped below $0 and how is that possible?
Right now, current oil supply far exceeds demand due to reductions in demand due to several factors including COVID-19 related lock downs and market oversupply. In addition, insufficient storage capacity has forced traders with expiring May contracts to pay to have someone take physical delivery of their oil which is why the price has gone negative. Even writing this article it is difficult to comprehend the fact that companies are being paid to take physical delivery of Oil. The June contracts are trading around $20/barrel suggesting that this could be a one-month phenomenon, but this will be very closely watched by the market.
Chart from www.CNBC.com
Although this was a unique day of trading in the oil market, we have been asked a lot recently about what impact lower oil prices will have on electricity costs in New England. Many customers are surprised to hear that lower Oil prices may actually cause their electricity supply prices to increase. To give you an understanding of New England’s generating portfolio, in 2019, Oil fired power plants produced 0.2% of all electricity generated for the region. This is in stark contrast to Natural Gas (48.5%), Nuclear (30.5%), Renewables (11.4%), and Hydro (8.9%).[1]
Since Natural Gas is the key price driver of electricity costs in New England, it is important to understand the impact that low Oil prices will have on Natural Gas prices. For domestic on shore production, Natural Gas is a byproduct of Oil production. With May prices below $0.00/barrel and June contracts around $20/barrel, domestic producers are not producing Oil profitably and we can expect to see a decline in domestic Oil production which will also result in less Natural Gas being produced. I do not expect an immediate impact on Natural Gas pricing, but the glut of Oil available in the market suggests that low Oil prices are here to stay for the next 6-12 months. In addition, many domestic oil producers are highly leveraged, and it appears likely that not all companies will survive.
Overall, the Oil and Gas industry in the United States is in a very difficult position due to low Oil prices, lack of available storage, lack of demand, and highly leveraged balance sheets. The government has tried to prop up the industry by buying oil and filling reserves, but after today’s trading it looks like there is going to be more pain ahead. I think we will see some of the more highly leveraged produces struggle and bankruptcies will be inevitable. Finally, I believe that this will result in Higher Natural Gas and electricity prices as production is cut in the next 6-12 months.
[1] ISO-New England. “Resource Mix.” Resource Mix, www.iso-ne.com/about/key-stats/resource-mix/.
About Pursuit Energy Solutions
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