Oil prices may have surged 25% Thursday to set a record intraday gain on the back of optimism that Russia and Saudi Arabia might reach a production truce to buoy prices, but that doesn’t necessarily mean the commodity is in the clear just yet.
After trading above $45 a barrel earlier in the year, the price of West Texas Intermediate has cratered as oil suffered a one-two punch of rising supply due to a failure of Saudi Arabia and Russia to agree on production cuts and the coronavirus crisis leading to a complete collapse of demand.
While President Trump fueled optimism for a deal Thursday by tweeting, “that they will be cutting back approximately 10 Million Barrels” in production, one analyst who correctly called oil’s collapse to $20 is pouring cold water on the idea that it will be enough to reverse oil’s bearish trend.
“I know Trump is talking about these tweets about pulling production, it is not enough without the other side of the equation, the demand side,” oil analyst and editor of The Schork Report Stephen Schork told Yahoo Finance. “We can tweet all we want about production cuts, it is a demand story. Right now there is no demand because we have killed our economy, Europe has killed its economy, Asia has killed its economy.”
The domino effect
Since the coronavirus has spread around the globe and country after country opts to shelter in place, demand for oil has quickly contracted, perhaps most notably seen here in the U.S. as pipeline operators ask drillers to curtail production as storage reaches max capacity. That led some crude varieties to see prices plunge by an even higher margin, like Wyoming Asphalt Sour, a denser oil used primarily for paving bitumen, to even see prices dip below zero.
With that much pent up supply here in the U.S., Schork says even with accommodative cuts abroad, more expensive domestic drillers are going to be stuck with nowhere to store their crude.
“I don't care how much oil we pull off, we are going to be at constraints by the fourth of July holiday meaning that there is going to be no place to put excess oil and the demand is not there,” he said, adding that prices could collapse to set a new all-time record below the 1986 mark of $9.75 a barrel before the coronavirus shutdown subsides. “This is still a very long term bearish scenario in this market.”
The downtrend has been putting excess pressure on American oil producers, who generally have higher costs of production than international producers. That led to one of the first bankruptcies among the major producers this week, with shale giant Whiting Petroleum filing for Chapter 11 bankruptcy protection with more than $3.6 billion in debt. Schork says it’s inevitable that more will follow.
“That’s the first domino. So you will see a considerable amount of dominos falling the next few years as these oil [exploration & production companies] with some of the lighter balance sheets have to end up closing shop,” Schork said.
If oil does follow his projection below $10, it’s hard arguing with that math.