You may have seen a number of headlines recently about negative oil prices and scratched your head, wondering how something so ubiquitous could cost a negative amount of money. Is the fossil fuel industry experiencing a momentary blip in reaction to the COVID-19 crisis, or is the industry in bigger trouble? There’s a lot going on, so this is my attempt to break it down.
Why are oil prices negative?
Simply put, the oil market is experiencing an unprecedented drop in demand while simultaneously facing a huge excess in supply. Back in March, when demand for oil began to decline in response to COVID-19, Saudi Arabia and Russia began a price war to capture the dwindling market. Meanwhile, much of Europe, Asia, and the US issued stay-at-home orders and closed international borders, effectively ending most air travel and transportation, which uses up around one-third of the oil produced. So now we have companies pumping out tons of oil at the same time no one wants to use that oil.
Earlier this month, OPEC+ and the US agreed to cut production by 9.7 million barrels of oil per day. Analysts largely agree that this cut will meet less than one-third of the overall drop in demand, and the cuts don’t even start until May. For much of April, oil companies have refused to shut down or reduce operations because there are high costs and potential complications with restarting wells. All that oil has to go somewhere if it’s not being used, and storage space is quickly running out.
US oil markets are quirky
My very first economics professor liked to tell a (likely fictional) story about someone who purchased two tons of soybeans in the 1980s, and couldn’t find any buyers. So two tons of soybeans were dumped on his front lawn. The moral of this story, and the story of the negative oil prices, is to always keep your commodities trading in the abstract only.
Which brings us to the negative prices last week, which are a quirk of the oil market. Let’s say you’re a commodities trader. You spent $60 for a barrel of West Texas Intermediate Oil (WTI – a common US standard) back in January, to be delivered in February. But you don’t ever want to actually have that oil physically delivered to you–it’s a toxic, flammable, polluting sludge and you as an individual have no use for it. So you keep rolling over that investment, switching to delivery to March and then to April.
But last Tuesday was the last day to sell oil futures before they were delivered in May. And no one wants oil delivered in May, including refineries. Instead, people were willing to pay to store that oil and not have it delivered, so it’s being kept in offshore tankers, storage facilities, and even in pipelines (which is an environmental catastrophe waiting to happen).
Even if we look forward to a full year ahead, barrels of WTI to be delivered in May 2021 are only trading near $30 per barrel. Last February, the oil majors rolled out predictions of $60 per barrel for the next year but reassured investors that they could still make a sliver of profit at $40 per barrel. We ended last week just over $15 per barrel, so how will the oil majors squeak by?
Companies trim fossil fuel development budgets
At this point, many major investor-owned oil and gas companies have cut their capital expenditures (capex) to cover some of their losses. Capex covers all the funds used by a company to acquire, upgrade, and maintain physical oil and gas assets and undertake new oil and gas projects or exploration. Which makes sense, as there’s no reason to invest in new projects that pump out more oil if there’s no profit in the barrels sold.
- Shell reduced its capex by at least $5 billion at the end of March and has declared that it aims to cut operating expenses (the cost of continuing typical business operations and production) by $3 billion-$4 billion.
- Chevron has announced a capex reduction of $4 billion.
- ConocoPhillips has announced it would decrease oil production by 225,000 gross barrels of oil per day, as part of the company’s $4.3 billion expenditure reduction.
- BP has reduced its capital budget by roughly 25 percent, leaving the company with $12 billion in spending.
- ExxonMobil reduced its capex budget by 30 percent in early April, which amounts to around $10 billion.
With oil prices likely to be depressed for some time, as these companies offload the excess oil and gas supply and communities reopen piecemeal, it is unlikely to see high levels of capital expenditure again in the next few years.
A few steps forward on climate, but not enough
There has been some progress on climate this year by a few of the oil majors. Back in February, BP announced a new ambition to reach net-zero emissions by 2050, including emissions from the burning of BP’s oil and gas products (scope 3 emissions). BP also promised to halve the emissions intensity of the products it sells, which could be substantial. While the company didn’t release a huge amount of detail, as discussed in my earlier blog, it was clear that BP intended to restructure its organization and put some effort into developing carbon capture and storage (CCS) and renewable technologies. The company also put out a trade association audit in February and left several industry groups over climate policy misalignment.
And just a few weeks ago, Shell also updated its stated climate “ambition” to be net-zero by 2050, including the burning of its products, although the press release offered essentially no useful information beyond a push for renewable energy and electrification. My colleague Kathy Mulvey’s blog analyzed Shell’s announcement in detail, including Shell’s update to its trade association report.
There is a concern that the drop in oil prices could cause a money crunch that would delay either Shell or BP’s energy transition, including curtailed investments in renewable technologies and CCS. But that both these companies announced a goal to reach net-zero by mid-century in the same season has made a significant change in the narrative around what oil majors can and should do.
It has also highlighted the split between European and US oil majors–while BP and Shell are at least making big statements, ExxonMobil and Chevron are doubling down on minimal climate action and refusing to take responsibility for the emissions that come from burning their products. Chevron’s CEO Mike Wirth even criticized BP’s new ambition in its analyst call last month, saying that Chevron would promise shareholders what it could deliver (which is only a 5 percent reduction in operational emissions–hardly ambitious or what’s needed). Chevron and ConocoPhillips have both seemingly decided not to update their climate transition reports to shareholders, relying on the limited information they provided last year.
Short term uncertainties leave long-term climate goals in the lurch
The fossil fuel industry is in an unprecedented situation. Because the US shale oil market was never strong even before COVID-19, we’ll likely see a wave of bankruptcies and acquisitions from smaller upstream companies. Looking forward, no one can pinpoint whether or when the price of oil will recover to pre-pandemic numbers, or when demand will increase again.
One important point to make in the current situation–we should not mistake year-to-year or month-to-month fluctuations in carbon emissions caused by short-term changes to the economy with the long term, sustained, deep reductions in heat-trapping emissions that we need.
There is a critical difference between emissions reductions occurring due to lessened fossil fuel consumption from reduced mobility and economic activity, and emissions reductions occurring due to the replacement of polluting fossil energy sources with clean renewable energy—the latter enables emissions reductions while also powering a prosperous economy.
There are a lot of unknowns about everything right now, including oil and the climate. But what’s needed from fossil fuel companies in a carbon-constrained world remains the same. If we’re to avoid the worst effects of climate change, these companies must commit–not just announce ambitions–to achieve net-zero absolute global warming emissions by mid-century and conduct all activities in ways that are verifiably consistent with this commitment.