West Texas Intermediate (WTI), the oil grade most associated with American production, plunged to almost minus US$40 on 20 April. For a while, sellers had to pay people forty bucks to take a barrel of crude.
As with any product, the business of oil isn’t a once-and-done. It must be produced, shipped and processed, and then the refined product must be shipped and retailed. What happened on 20 April was a bottleneck in that process. Production surged ahead of pipeline shipping capacity, leaving some producers with nowhere to put their crude.
But it was only the beginning
The real kicker is that this is not the ‘negative prices’ outcome I predicted a couple weeks back. ‘All’ the April 20 event was, was a single facility in a single country running out of future leased storage capacity for the month of May. The 20 April price crash will happen again in the same place and it will be bigger. June WTI futures contracts are now spazzing, and America’s Cushing oil storage and transport nexus undoubtedly will be actually full by then. But even this is nothing but the warm-up for the big show.
That will happen when the world runs out of storage.
Numbers are fuzzy in this corner of global oil markets, in part because everyone classifies and categorises their oil storage capacity differently. First, because they should, since gasoline storage is functionally different from raw oil storage. Second, because some countries don’t share data due to secrecy.
But no one thinks there’s a whole lot of storage capacity left. Global oversupply of crude right now is over 20 million barrels per day (mbpd), with 30 mbpd seeming to be the ‘average’ oversupply guestimate. What storage remains could be filled up completely sometime in May or early-June.
Good or bad for Saudi Arabia?
And filled up it will be, because that is the express goal of the world’s largest oil exporter, Saudi Arabia. The Saudi price war started out as a spat with the Russians over carrying the burden of a production cut. It has since expanded into the Saudis targeting the end markets of what they consider to be inefficient producers. The Saudis are directly targeting markets previously serviced not just by US shale and Russia, but those serviced by Kazakhstan and Azerbaijan and Libya and Iraq and Iran and Malaysia and Indonesia and Mexico and Norway and the United Kingdom and Nigeria and Chad and ... you get the idea.
As of 21 April, there were still at least 24 supertankers carrying at least 50 million barrels of Saudi crude en route to the U.S. Gulf Coast. Most will arrive in May, seeking to fill up as much of what remains of U.S. storage as possible. Similar volumes are en route to Europe and even bigger volumes to Northeast Asia. In most cases the destinations are the trans-shipment nodes that enable distribution of inland-produced oil to coastal locations: Rotterdam, Suez, Singapore, Korea.
Assuming you’ve got deep pockets, and Saudi Arabia’s are some of the world’s deepest, it isn’t a stupid strategy. If the Saudis can push prices firmly negative, it will absolutely crush many of the world’s energy producers. My back-of-envelope maths suggest some 20 million barrels per day of production capacity – one-fifth of global output – will go offline for years.
Then Riyadh will have what it wants: the ability to raise prices as much as it wants and to reign supreme over the world of oil for at least several years. The WTI price crash on 20 April confirms that if the Saudis didn’t realise the potential for their strategy’s explosive success before, they certainly do now. They have no reason to back down.
There are a few producers worthy of callouts.
- Canada’s Alberta province has the most to lose. Not only landlocked, it must sell all its oil into the American market that is already so saturated. Its production must be shut in for years.
- Venezuela was facing civilizational collapse due to mismanagement before oil prices tanked. As oil is the government’s only remaining income stream, this marks the end of Venezuela. Its oil will not come back for at least a decade, and even then only if an outside power first physically invades the place to rebuild the country from scratch.
- America’s sanctions regime against Iran has been so successful the country isn’t an oil exporter any longer. Its output will absolutely collapse this summer, and the country lacks the funds to bring in foreigners to help restart it or the skills to do the work itself.
- Russian fields are in swamps and permafrost. Drilling is only possible during the winter. Any shut-ins mean the wells freeze solid, necessitating completely new drilling. Last time this happened, it took the Russians nearly 15 years to get production back.
- Azerbaijan and Kazakhstan are both dependent upon other countries (in some cases, Russia) to transit their crude to market. High production costs plus finicky neighbors equal long-haul shut-ins.
- Nigeria is a mess on a good day, and the supermajors who have made Nigerian output possible have steadily moved offshore to get away from the chaos and violence. Once they turn off their wells, they won’t even consider returning until global prices rise to the point that they are once again willing to subject their staff to frequent kidnapping. That’s several years off.
- Iraq has been in a state of near civil war for some 15 years. The country is now producing over 4mbpd, the income from which helps hold the place together. Negative prices will remove the ‘near’ from the country’s political condition and (at best) make the place a ward of the Arab states of the Persian Gulf.
Tanker storage capacity disappearing
It is also worth noting that the speed that this could all go from head-spinning to head-chopping is intensely short. Right now there’s still a fair amount of spare oil tankers to shuttle about the world. The Saudis have been leasing out every tanker they can find, so before long all the world’s tankers will be full as well.
Oil has been a panacea for all sorts of inefficient, compromised, and in some cases evil regimes for decades. Huge demand in the West and Northeast Asia allowed a raft of previously insignificant or morally reprehensible leaders and societal situations to effectively print dollars out of the ground and count the industrialised world as a hungry customer.
Not anymore. Demand patterns have shifted, the United States is now an exporter of crude oil and products, and the petro-economy that has kept regimes afloat is crumbling. Before anyone cheers, it’s worth remembering that things will get a lot uglier before they have any hope of improving.
For a good idea as to the flavour of ugly, my new book Disunited Nations has full chapters on three of the world’s most distorted and bizarre oil-based economies: Russia, Iran and Saudi Arabia. Their struggle with the world-to-come is going to be a crazy ride.
Peter Zeihan is a geopolitical strategist, speaker and author. This article is general information and does not consider the circumstances of any investor.