Oil prices fell sharply during Monday trading after a steady decline that has now continued for two weeks, owing in large part to investor fears of further lockdown measures in response to a surge in the spread of COVID-19.
Come morning trading on Tuesday, it became apparent that oil was holding its losses. Crude hit around $39 per barrel at 8:45 am in London, while Brent sat at around $41 following a 4.5% drop in price on Monday. Both losses stemmed from a broader market sell-off.
The price shock follows the reimplementation of lockdown measures in the UK in response to rising coronavirus cases, with Cabinet Office minister Michael Gove advising that Brits should work from home “if possible” to avoid spreading the virus further. Local lockdowns have also come into effect in the Madrid region since Monday, affecting nearly a million people, and the rate of infection is currently rising in France, Belgium and Lebanon.
During the height of the “first wave” in March and April, when lockdown measures were at their most severe, oil prices fell to their lowest level ever seen – West Texas Intermediate even dipping below 0% for the first time in history as demand for oil ran dry.
In addition to the growing possibility of new lockdown measures, Saturday also saw an announcement from the Libyan National Petroleum Company that it would restart its production and exportation of oil, potentially sparking a supply glut.
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Last week, oil giant BP’s influential annual energy report said that demand for oil may never fully recover from the impact of COVID-19, and that “peak oil” may now be past. The company has already begun to transition away from fossil fuels and toward a carbon-neutral energy infrastructure.
Benchmark oil prices reached their highest level in five months on Wednesday as hundreds of US offshore oil facilities were closed in preparation for the arrival of Hurricane Laura.
310 facilities in the Gulf of Mexico were evacuated, effectively halting 84% of oil production in the Gulf – equivalent to a loss of 1.56 million barrels per day – and at least a third of synthetic rubber capacity in the US. The scale of the shutdown is comparable to the 90% production outage caused by Hurricane Katrina in 2005.
The news pushed oil futures contracts to their highest prices since early March, before the US and other nations first implemented lockdown measures in response to the COVID-19 pandemic.
Brent crude rose 0.4% to $46.05 per barrel in early Wednesday trading, and West Texas Intermediate rose 0.2% to $43.43 per barrel.
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According to Reuters, AxiCorp’s chief global markets strategist Stephen Innes commented: "Markets are currently pricing in a possible near-term catastrophic gasoline shortage."
Hurricane Laura is expected to make landfall on Thursday near the Texas-Louisiana border, where many petrochemical plants and refineries are situated. The National Hurricane Centre predicts that it will be a major hurricane with wind speeds of at least 111 miles per hour by time of landfall.
One day after Saudi Aramco CEO Amin Nasser told reporters that “The worst is likely behind us,” global markets have seen an oil price surge.
Brent futures rose to $44.79 per barrel – an increase of 0.8% -- and crude saw a 1.2% rise to $41.75. This is still far below the average $60 per barrel that crude futures were trading at when the year began, but appreciably higher than the negative prices seen in April.
As a consequence of the price increase, oil stocks were boosted worldwide. BP began trading 3.5% higher, and Royal Dutch Shell also saw a 2.5% surge.
Saudi Aramco saw its own modest stock increase of 0.3%. The company reported a 73% loss of profit in the second quarter, but has committed to maintaining its $75 billion dividend pledge regardless.
The cost of oil plummeted early this year in the wake of both a price war and the outbreak of the COVID-19 pandemic, which drove demand through the floor.
Paul Hickin, associate director of EMEA Oil News at S&P Global Platts, commented on the perception that shaped this latest pricing shift. “The market is really trading on different bits of news that come out, good and bad, around that demand narrative,” he said.
“Really it’s demand that’s the big driver. Where is the market seeing demand going? There’s still huge questions in markets around that.” He added that S&P Global Platts expects that oil prices will struggle to remain above $40 per barrel in the months to come.
Shell’s Q2 earnings report, released on Thursday, revealed that the company had suffered a net loss of $18.3 billion, a striking departure from its $3 billion profit during the same period in 2020 and a $2.7 billion profit in the first quarter of 2020.
What might have been Shell’s worst quarter in company history was saved by its oil trading business, which went some way towards shoring up profit margins.
Investor attitudes were largely unaffected by the disappointing earnings report; shares were only down by 0.5% in early London trading. A reason for traders’ optimism can be found in Shell’s adjusted income: while the reported $663 million represents an 82% drop from the same period in 2019, it greatly surpassed analysts’ expectations of a $664 million loss.
However, Shell was still forced to downgrade the value of its oil and gas assets, confirming $16.8 billion in post-tax impairments costs in its release.
Shell CEO Ben van Beurden praised the company’s “resilient cash flow in a remarkably challenging environment” in a statement on Thursday.
“We continue to focus on safe and reliable operations and our decisive cash preservation measures will underpin the strengthening of our balance sheet,” he continued.
In April, Shell announced its intention to scrap all executive bonuses for the financial year, in addition to cutting budgets and costs in an effort to save up to $9 billion. It may also consider issuing voluntary redundancies later in the year.
In a report on its second quarter earnings, Shell announced that it would cut between $15 billion and $22 billion from the value of its assets due to the collapsing price of oil and unlikeliness of a swift recovery.
Shell also predicted that the price of Brent crude oil would average at $35 per barrel through 2020, with a potential return to $60 per barrel – where it began this year – in 2023. The price of Brent crude has seen something of a rebound in recent weeks and is now trading at $41 per barrel. At the peak of the oil crisis, it traded at just $20 per barrel.
“Given the impact of COVID-19 and the ongoing challenging commodity price environment, Shell continues to adapt to ensure the business remains resilient,” the company said.
Shell’s warning follows a similar announcement from BP earlier this month, alerting investors to the fact that its assets may be worth $17.5 billion less than previously thought.
The first half of 2020 has seen oil prices plummet, driven in large part by the COVID-19 pandemic and resulting shelter-at-home orders that saw air travel halted and a steep decline in the use of motor vehicles and public transport.
Market conditions were further stressed by the brief Saudi-Russia oil price war that launched in March, vastly inflating the global oil supply. The combination of stressors in April saw US crude oil futures reach negative prices for the first time in history.
In a statement on Monday, BP confirmed that it plans to sell its global petrochemicals business to INEOS for a total consideration of $5 billion.
In addition to meeting BP’s goal of divesting $15 billion worth of assets, the move fits new CEO Bernard Looney’s wider plan of radically overhauling BP from an oil giant into a key player in the clean energy market. Looney lauded the petrochemicals sale as “another significant step” towards reinventing BP as a company that can survive the energy transition.
“Strategically, the [petrochemical business’s] overlap with the rest of BP is limited and it would take considerable capital for us to grow these businesses,” the CEO said in a statement. “As we work to build a more focused, more integrated BP, we have other opportunities that are more aligned with our future direction.”
In a statement of his own, INEOS’s billionaire founder Sir Jim Ratcliffe said: “We are delighted to acquire these top-class businesses from BP, extending the INEOS position in global petrochemicals and providing great scope for expansion and integration with our existing business.”
BP’s petrochemical interests have been struck hard by 2020’s sharp decline in oil prices, leading to a write-down of between $13 billion and $17.5 billion in its earnings for Q2.
As part of the agreed terms of the sale, INEOS will pay a deposit of $400 million and a further $3.6 billion upon competition, with the remaining $1 billion to be paid in instalments between March and May 2021.
In a webcast to employees on Monday, BP chief executive Bernard Looney announced that 10,000 jobs will be cut due to the effect of COVID-19 on oil prices.
“The oil price has plunged well below the level we need to turn a profit. We are spending much, much more than we make,” he said.
Looney said that BP’s senior roles would “bear the biggest impacts”, with a new company structure seeing the number of senior-level jobs halved and group leaders cut by a third. “The majority of people affected will be in office-based jobs. We are protecting the frontline of the company and, as always, prioritising safe and reliable operations,” he continued.
This new round of layoffs, most of which will be resolved by the end of the year, marks the end of BP’s three-month redundancy freeze that has commenced since March.
In addition to reducing BP’s capital expenditure by $3 billion and operating expenditure by $2.5 billion in 2020, Looney also suggested that the company will soon be refocusing its efforts to transition away from fossil fuels, and that the COVID-19 pandemic may accelerate the process.
“To me, the broader economic picture and our own financial position just reaffirm the need to reinvent BP,” he said. “While the external environment is driving us to move faster — and perhaps go deeper at this stage than we originally intended — the direction of travel remains the same.”
Since his appointment to CEO in February, Looney has already pledged to transform BP into a carbon-neutral company by 2050.
In several sectors of the economy, negative prices have existed for years, meaning that it is not the seller but the buyer of a product who is paid. Examples can be found in power generation and banking. Triggers are imbalances between supply and demand and marginal costs of zero or below.
In the traditional world of physical products, marginal costs are significant and so prices of zero are rare, and those below zero practically never occur. The Internet and other technologies are changing this situation fundamentally. For many digital businesses the marginal cost of an additional product unit is often zero or close to zero – for example adding a new subscriber to a streaming service such as Netflix.
We’ll now cover three interesting scenarios where these effects can be observed.
Negative prices from oversupply
At the European Power Exchange the number of hours with negative electricity prices has increased from 15 hours in 2008 to 211 hours in 2019. Last year, the power producer paid the buyer a (negative) price per megawatt hour for almost ten days. The buyer received the electricity plus money. How can this be explained?
In this case, even when demand for electricity is low, stopping production is not possible. In order to be able to produce on days with positive prices and make a profit, the producers must subsidize the electricity on days with negative prices.
With the negative oil prices we are currently observing, we encounter the same conditions. It is more advantageous for the oil producer to pay the buyer something in addition than to interrupt production or rent expensive storage capacities.
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Negative interest
Interest is nothing other than the price of money. Negative interest rates were first observed in Denmark in 2012. Today they have become a widespread and much discussed topic. In some cases we have seen negative interest rates on loans… so a financial institution is paying someone to take a loan!
For European banks it can be more profitable to lend the surplus money at an interest rate of -0.2% instead of depositing it at the central bank and having to pay negative interest of -0.5%. And if depositors are willing to provide the bank with money at a negative interest rate, the bank can lend this money at a negative interest rate and still achieve a positive contribution margin.
Pricing when marginal costs are negligible
In traditional transactions, from the seller's point of view, the theoretical short-term lower price limit is the marginal cost, which means that he or she only sells a product at a positive contribution margin.
That said, a price of zero is common in promotions. Free samples (for pharmaceuticals or consumer products, for instance), are widespread for new product launches. This tactic makes sense if the price of zero stimulates sales in subsequent periods.
These tactics become even more powerful for subscription services such as online news subscriptions or streaming music/video services. That is why so many offer a 30-day free trial, because once the subscription is started then future sales are almost 'automatic'.
However, the question arises why zero should be the lower price limit in this situation. With marginal costs of zero this option becomes much more attractive than with the significant marginal costs in the traditional economy.
For many digital businesses the marginal cost of an additional product unit is often zero or close to zero.
In fact, such negative prices can be observed. Commerzbank has been crediting new customers with 50 euros for a long time, which means it pays a negative price. The same applies to the voucher of the same amount that METRO Cash & Carry gave to new customers.
In its initial phase, PayPal also used negative prices. Each new customer received 20 US dollars. In China, providers of bicycle sharing services such as Mobike paid their customers to use the bikes to return them from the suburbs back to the centre of the city, where they are needed more.
Ultimately, the question is how marketing and promotional measures work compared to negative prices. Product launches are regularly supported with substantial budgets. The funds flow into instruments such as advertising, displays, promotions and discounts. A negative price can be more effective than advertising or similar measures without having to provide larger budgets.
More negative pricing as a deliberate tactic?
It is likely that we see more negative prices in the future. As we write this, the COVID-19 crisis is causing markets to experience supply and demand spikes like never before. This not only upsets the traditional short-term equilibrium but will also have some lasting effects to customer buying behaviour and their appetite for risk.
Will negative prices be used by new entrants as a way to disrupt established markets? To arrive at an optimal outcome, the effects of promotional measures and negative prices must be quantified. In the Internet age, it can be expected that investments in negative prices will increasingly pay off in the future.
Professor Hermann Simon is founder and honorary chairman of Simon-Kucher & Partners, the world’s leading price consultancy. Mark Billige is Chief Executive Officer of Simon-Kucher & Partners.
During Monday trading, price of West Texas Intermediate (WTI) crude oil fell from $18 to -$38 per barrel, the first time in history that the US oil benchmark has fallen into negative territory, resulting in cases where buyers were paid to accept oil.
Stewart Gickman, an analyst at CFRA Research, described the price shock as “off-the-charts wacky”, having “overwhelmed anything that people could have expected.”
The unprecedented price drop comes as a consequence of the system of purchasing oil through futures contracts and how they work. WTI futures contracts, which require buyers to take possession of oil in May, were set to expire on Tuesday, resulting in a mass sell-off due to a lack of available space to store the oil once it is shipped.
Now that this deadline has arrived, WTI crude prices have seen the beginnings of a recovery, though they have not yet reached $0.
International prices have also slipped, with Brent crude falling more than 20% to less than $20 a barrel on Tuesday morning. The global supply disruption caused by the COVID-19 crisis has resulted in an extreme fall in demand that is likely to persist throughout April.
The impact of the coronavirus pandemic has also coincided with an oil price war between Saudi Arabia and Russia that saw both sides pledging to increase oil production to historically high levels. Though this price war has since ended, the increased supply undoubtedly contributed to the current glut.
Aaron Brady, vice president for energy oil market services at IHS Markit, described the problem to the New York Times. “If you are a producer, your market has disappeared and if you don’t have access to storage you are out of luck,” he explained. “The system is seizing up.”
The FTSE 100 crashed on Monday morning as Saudi Arabia moved to begin a price war on crude oil, vowing to cut prices by $6 per barrel in April.
This price cut – the largest that Saudi Arabia has ever declared – came as OPEC failed to reach an agreement on oil production with Russia, its supply cut pact partner. Saudi Arabia now reportedly plans to put pressure on its rival producers by flooding the market with cheap oil.
The move has panicked investors globally, adversely impacting share prices across London’s foremost listed companies.
Neil Wilson, chief market analyst of Markets.com, said that the event would be remembered as “Black Monday”, and warned of the negative impact that the stock decline is likely to have on firms.
Wilson added that falling stock prices could cause “an aggressive tightening in credit that can spiral into real financial distress”, echoing fears of a recession that have grown amid the worsening coronavirus pandemic.
Nigel Green, chief executive and founder of deVere Group, also emphasised the compounding worries of the market.
“Oil’s sharpest one-day drop since the 1991 Gulf war has further fuelled the sell-off in global stock markets that started a couple of weeks ago on fears that coronavirus is going to severely damage economic growth,” he said.
Confirmed coronavirus cases saw a sharp rise over the weekend, with Italy taking the radical measure of quarantining fifteen of its central and northern provinces following a weekend increase of cases from 1,200 to 5,883. Milan, the financial capital of the country, has also been affected by the measures.
Following the increased anxiety about coronavirus’s effect on international market and the more recent oil shock, Monday’s mass sell-off has caused the FTSE to drop to its lowest level in three years.
The company’s report, ‘Saudi Aramco After IPO – Company Overview and Development Outlook’, reveals that five major expansion projects – four crude and one natural gas – are being planned to boost output in the country.
One eighth of the world’s crude oil from 2016 to 2018 was produced by Saudi Aramco. As well as being the world’s largest oil producing company, it is also the most reliant on oil production, with 88% of its total 2018 upstream production coming from crude.
Somayeh Davodi, Oil and Gas Analyst at GlobalData, commented: “The major expansions at Saudi Aramco’s offshore oil fields of Marjan, Zuluf, Safaniyah and Berri are expected to comprise the majority of the company’s upstream investment over the next three years. Although these developments will also add gas and NGL capacity, the main addition will be oil.”
In 2018, the company’s MSC capacity (maximum barrels of crude oil that can be produced during a year) was 12 million barrels per day (bd) with 10.5 million bd oil produced plus the remaining 1.5 million bd available as spare capacity. This capacity allows flexibility to respond to market supply and demand fluctuations. The new expansions will add 1.45 million bd additional oil capacity.
Davodi adds: “Future production, including the ability to realize output gains from new capacity additions, is likely to be highly dependent on OPEC quotas. Production cuts are set to continue into 2020, but could be extended further.”
Nigel Green, the chief executive and founder of deVere Group, explains that as Tehran threatens “revenge” on the US over the killing of Qassem Soleimani, the commander of Iran’s elite Quds Force, who was in charge of the country’s regional security strategy.
It remains uncertain how, when, or if Iran will respond, but any retaliation is unlikely until after the end of three days of mourning.
Last week we saw the price of oil jump as a result of political tension. This week, Bitcoin, the world’s largest cryptocurrency by market capitalisation, jumped 5% as news of the strikes broke around the world on Friday. Simultaneously, the price of gold – known as the ultimate safe-haven asset - also moved higher.
We’ve seen Bitcoin price surges before during times of heightened geopolitical tensions. For instance, in August it jumped as global stocks were rocked by the devaluation of China’s yuan during the trade war with the US.
According to Nigel Green, this latest Bitcoin price increase underscores a mounting consensus that Bitcoin is becoming a flight-to-safety asset.
“Bitcoin is living up to its reputation as ‘digital gold’. Bitcoin - which shares gold’s characteristics of being a store of value and scarcity and of being perceived as being resistant to inflation – could potentially dethrone gold in the future as the world becomes increasingly digitalised.”
He continues: “With an escalation in geopolitical turbulence, which typically unsettles traditional markets, it can be expected that a growing number of investors will decide to increase their exposure to decentralised, non-sovereign, secure currencies, such as Bitcoin, to help protect them from the turmoil.
“The serious concerns created by geopolitical issues, such as the US - Iran issue will likely prompt an increasing number of institutional and retail investors to diversify their portfolios and hedge against those risks by investing in crypto assets.
"This will push the price of Bitcoin higher. In turn, due to the market influence of Bitcoin, other major digital currencies will receive a price boost.”
The deVere CEO concludes: “Bitcoin was one of the best-performing assets of 2019 and we can expect to see its investment appeal further strengthen as it becomes known as a safe-haven asset during periods of heightened geopolitical tensions.”
