Everything You Need to Know About the Oil Market

Everything You Need to Know About the Oil Market

Dear Money Revealed Reader,

Supply chains have experienced unprecedented levels of wonkiness so far in 2020. Toilet paper and face masks have become coveted items. This would have been unthinkable just six months ago…

Manufacturers and producers struggle with social distancing and safety protocols while changing production to meet demands for ventilators and bread yeast and the sudden drop-off in the American consumer’s desire to eat green beans.

Domestically drilled and refined oil has its own unique set of issues. With everyone staying home, demand has sharply decreased.

gallon

OPEC-Russia woes and the coronavirus shutdown have conspired to harm the steady supply of U.S. domestic production. In fact, West Texas Intermediate crude (WTI) went for a healthy $60 per barrel at the start of 2020, as reported by CNBC.

Prices Go Negative

History was made on Monday, April 20, when WTI futures dropped to a negative $37.63 per barrel.

So how does this happen? And why didn’t the price of gasoline at the pump drop at a similarly precipitous rate?

If you visit the honorary twin capitals of the West Texas oil patch, the cities of Midland and Odessa, you will notice that the landscape stretches as far as the eye can see. Sure, there are some ranches, some cotton fields and winter wheat in its season, but otherwise, there is not much to see except for the occasional oil pump.

oil machine

West Texas sits atop a sea of oil, the prehistoric Permian Basin, and in recent years the perfect economic storm has made it profitable to drill and produce a constant flow of oil from this vast region.

Yet while West Texas was an actual sea in prehistoric times, it no longer enjoys waterways in which it could transport oil to the rest of the nation and the world. Instead, WTI is beholden to pipelines, tens of thousands of miles of them, according to the Railroad Commission of Texas.

The logistics of switching up the manufacturing and production of any product are not without hassles. An auto factory can’t just switch to making ventilators overnight, and one pillow company had its own logistical hoops to jump through to switch its production to personal protective equipment. Farmers lose man-hours and income when they have to plow under a field, and the producers of bread yeast can’t change Mother Nature’s timing and instantly produce more of their product.

But oil pumps are even more inflexible in their timing and production levels. They simply do not have an off switch, and in some cases are more costly to shut down than to take a loss on on the production.

Add to that the fact that excess oil cannot be plowed under, dumped or cheaply stored.

In fact, crude oil produced in prior weeks is still traveling throughout the nation in the approximately 72,000 miles of pipeline that crisscross our nation, according to Pipeline101.org.

It all adds up to a conundrum in which the supply is not diminishing anytime soon, yet the demand, refining capacity and storage options are becoming more problematic.

And that’s how people found themselves in the unprecedented situation of having to pay people to take crude oil contracts off of their hands…

“If you get stuck holding an oil futures contract after trading in it ends, you may be obligated to actually take delivery of actual crude oil,” writes Josh Barro in New York magazine, “so investors who aren’t actually in refining or other oil-consuming fields have to get rid of their contracts, and that has led to some screwy activity in a market with thin trading.”

oil

What Role Does OPEC Play?

It certainly didn’t help that Russia and OPEC’s Saudi Arabia ignited an oil war that sent WTI plummeting in mid-March, just as world markets were spasming in reaction to the coronavirus pandemic.

But most market analysts believe that the oil war issue has been addressed — at least in the near term. “Fifteen percent of this is Saudi Arabia and Russia and 85% of it is COVID,” RBN Energy CEO Rusty Braziel told CNBC’s Jim Cramer.

Travel restrictions and stay-at-home orders have conspired to make the oil war crisis worse than it otherwise would have been, creating a situation, according to Braziel, in which, “The entire world is long on crude oil and the entire world is short on storage capacity.”

So why hasn’t the price at the pump fallen to rock bottom in tandem with the drop in WTI?

There are several reasons for this, the primary being the refinement process — you can’t simply put crude oil into your gas tank. It takes time, logistics and manpower to refine it into the product you purchase at your local gas station. And as with anything else, there is a markup to cover the cost of doing business.

Because of lowered demand, some refineries have shut down temporarily. The Exxon refinery in Baytown, Texas, shut down in late March due to the lag in demand. This facility normally handles 560,500 barrels per day, reports Reuters.

And in a world that doesn’t seem to be tiring of historic firsts, the limits of oil storage capacity are being stretched worldwide. “Over 80 huge tankers, each holding up to 80 million gallons, are anchored off Texas, Scotland and elsewhere, with no particular place to go,” points out The New York Times.

“But if and when the economy gets back to roaring,” explains Barro of New York magazine, “the bust for oil producers in the current crash should lead to a more constrained supply. That could push prices up.”

With purpose,

Patrick Gentempo

Patrick Gentempo