Oil prices are historically a bellwether for the economy and right now, it’s looking like a winding path ahead. Oil prices are currently subject to unprecedented levels of volatility driven by geopolitical instability and plunging demand. Both the Russia-Saudi Arabia price war and the Safe at Home initiatives brought on by the COVID-19 (coronavirus) pandemic have sent oil prices down. Although oil prices are beginning to rally alongside the reopening of US cities and businesses, high inventories at US oil reserves and fears of renewed US-China trade tensions will continue to place downward pressure on oil prices in the immediate outlook period.
Low oil prices are both hurting and helping US companies depending on the industry. Low oil prices are squeezing energy and oil production firms because lower prices result in less earned revenue. Consider this: the US oil and natural gas industry supports 10.3 million jobs in the United States and nearly 8% of our nation's gross domestic product (GDP); therefore, negative effects on the oil and gas industry will be a detriment to the larger economy.
On the other hand, low diesel fuel and gasoline prices are helping offset the financial strain on companies that typically have high capital expenditures (CAPEX) on fuel costs (e.g. airlines, trucking industry, shipping, logistics). Nonetheless, lower gas prices are not enough to offset the adverse effects of the coronavirus on demand across companies that have high CAPEX on oil inputs. For example, according to US-based freight exchange service provider Dial-a-Truck (DAT), demand for trucking plummeted in April, falling an approximate 32% year over year (YoY) for vans and down 72% YoY for flatbeds. The negative impact on demand for national trucking services, third-party logistics, domestic air travel, shipping and other companies that rely on oil inputs exceeds the benefit of lower oil expenditures for these oil-dependent companies.
Price Snapshot: North American Oil & Gas
- On April 20th, a barrel of West Texas Intermediate (WTI) oil had a negative price tag of $37.63, meaning sellers had to pay buyers.
- By mid-May, the price of a barrel of WTI has rallied to about $32 a barrel.
- Canadian oil prices are rallying on supply shut-ins during the month of May. Shut-ins are a period in which an oil or gas well has available but unused capacity.
- The price of Western Canada Select rallied to about $26 per barrel as of Tuesday, but is still trading at a discount to WTI.
Key Takeaway: Prices will continue to rally in a volatile manner as demand rises alongside the reopening of cities and US businesses.
How Are Oil Companies Responding to Growing Financial Pressure?
- Oil companies are responding by cutting spending on capital expenditures (CAPEX) and exploration and production (E&P) budgets.
- US giant ConocoPhillips has started to cut its 2020 capital program by approximately 10% or $700 million.
- US market leader Chevron has set a target of $2 billion in cost savings.
- Imperial Oil, the third-largest petroleum company in Canada, cut production at its Kearl mine from 220,000 barrels per day (bpd) to 150,000 bpd.
- US company ExxonMobil announced capital budget reductions by 30%, some $10 billion, and cuts to its operating expenses by 15%.
- Shell Oil Company, the US-based subsidiary of Royal Dutch Shell, announced the reduction of underlying operating costs by $3 to $4 billion over the next year. The company also announced a reduction of cash capital expenditure to $20 billion, $5 billion below the original forecast for 2020.
Key Takeaway: North America’s largest oil companies are drastically cutting CAPEX budgets and halting output.
Looking Forward: What Are Experts Forecasting?
Looking forward, economists are essentially falling into two different theoretical camps on the trajectory of oil prices:
- Rystad Energy, a Norwegian energy research company, is more pessimistic about the outlook of oil prices. The research company and consultancy group forecasts that oil prices may range between $30 and $56 per barrel in 2020 and warned of more negative revisions to their forecast as demand plunges about 30 million barrels per day (bpd) in May. Furthermore, the consultancy warned that about $100 billion will be cut from oil companies’ E&P budgets in 2020, which may total $150 billion if oil prices remain below $30 per barrel into 2021 and result in significantly less spending on drilling and exploration equipment.
- Moody’s is more optimistic about oil prices in the three years to 2023. The ratings agency is expecting a bounce in oil prices in the medium term. They forecast that oil prices in the long term will range from $50 to $70 per barrel. In the short term, Moody’s is less optimistic and sees the effects of CAPEX cuts trickling down from E&P companies to oil and gas engineering service companies.
By: Riley Mallon
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