Lower For Longer: COVID-19’s Impact On Crude Oil And Refined Products
The price of crude has dropped to levels that we have not seen in a generation. The driver for this has been the disagreement between Russia and Saudi Arabia about decreasing production by 1.5 million barrels per day and instead increasing production by about 2 million barrels per day.
The global demand for oil until recently was about 100 million barrels per day. After nearly five years of oversupply, supply had finally come into close agreement with demand.
COVID-19 is adding another, and by most accounts a more serious complication, and one that will last longer.
The impact of COVID-19 has been vastly underestimated by agencies such as the International Energy Agency. They had recently suggested that demand might drop by 90,000 barrels per day; that compares to a prediction in December 2019 that demand would go up by 900,000 barrels per day.
A recent estimate by IHS Markit suggests that we might be in for a bigger shock. They predict that gasoline consumption in the US will drop by 55% for March and April due to COVID-19. They also indicated that jet fuel demand would be halved over the same period. Lastly, they suggest that diesel demand would be down by 20%.
What does this mean? In 2019, the US consumed 20.5 million barrels of crude oil per day. How was that crude oil consumed? On average, 45% of each barrel goes towards making gasoline; 25% towards diesel; 9% towards jet fuel and kerosene. The remaining 21% goes to heating oil, residual fuel, feedstock for plastics manufacturing and other products including paints, resins, etc. If the IHS numbers are correct, then COVID-19 would result in US demand for crude oil dropping to 12.5 million barrels per day. That’s a drop of a whopping 8 million barrels per day of crude oil, or 8% of global crude production!
However, refineries don’t work that way. They take in a staple diet of crude oil and churn out products in roughly the same proportion. Changing the output proportions would cause significant disruptions to refinery operations. Since diesel’s demand is least impacted because of its use in freight transport and will control refinery output, we anticipate that the crude consumption by the US will instead drop by 4 million barrels per day. But this will be accompanied with the rapid growth of inventories for gasoline and jet fuel, at rates of 30% to 35% of average daily consumption accumulating in storage tanks. Should COVID-19’s direct effects on the demand in the US last for two months (roughly how long it took China to start the recovery process), we would have built up additional reserves of gasoline and jet fuel that would last at least an additional month.
With the exception of China, the rest of the world’s economy, notably Western Europe and to a lesser extent South Korea and Japan, is under similar stress as the US economy. China has started to slowly recover after four months of economic pain. Given that, we anticipate that world demand for crude oil is probably down more than 10 million barrels per day, or down more than 10% from last year’s average consumption and production. The additional amount of crude being added into the market by Saudi Arabia and Russia will exaggerate this oversupply. The inventory of crude and refined products will continue to grow, so this oversupplied situation will persist for months after we have overcome the COVID-19 crisis.
It is no wonder that the Texas Railroad Commission, which oversees oil and gas production in Texas, and the US government are considering intervening to slow this inventory buildup using mechanisms not employed in at least 50 years. The Texas Railroad Commission is contemplating restricting production from the state’s oil fields and therefore putting its thumb on the price of oil – a role it had held until the OPEC-led price shock in the 70s. Similarly, the US government is contemplating barring imports of oil, a position it has not taken since the late 50s. While these are unusual times, such measures are unlikely to change the continued depressed price of crude and refined products that exist now and that will exist well after the COVID-19 crisis starts to recede.
We in Texas are looking at lower-for-longer for crude oil no matter what the Saudis and Russians do. And with the buildup of refined product inventories, the refining industry will continue to be depressed.