The Other Emergency Is Crashing Oil Prices

March 31, 2020

[Editor’s note: Tyee contributing editor Andrew Nikiforuk is the author of two best-selling books on epidemics: The Fourth Horseman and Pandemonium, both published by Penguin Books.]

A barrel of Western Canadian Select diluted bitumen reached a record low of US$7.63 this week.

Meanwhile a black market bottle of Purell hand sanitizer fetched $138 on the internet.

There you have the frenzied volatility seizing global oil markets as the economy slows to a crawl around the world.

One bottle of hand sanitizer is worth more than 18 barrels of Canadian heavy sour crude at the same moment that conventional crude dropped to historic lows below $30 a barrel.

While most Canadians have been worrying about the COVID-19 pandemic, the drama of collapsing oil prices has upended markets and shaken the budgets of Canada’s petro-dependent provinces: Newfoundland, Saskatchewan, Alberta and B.C.

If the price collapse lingers for months, some experts predict, it could trigger a major economic contraction on the scale of the Great Depression in the 1930s.

“The prolonged hiatus in economic activity particularly in the United States and China makes a global depression practically unavoidable,” said the highly respected Houston oil analyst Art Berman on his popular website.

Low oil prices reflect the economic shrinkage now occurring around the world amidst the pandemic.

If those prices stay low, they will also squeeze the revenue stream of the world’s highly volatile petro-states and could provoke a financial collapse for their bankers and creditors.

It’s not just the coronavirus

A constellation of events have precipitated the collapse.

COVID-19, which erased trillions of dollars from the Chinese economy, has killed oil demand by millions of barrels a day as flight cancellations, industrial shutdowns, quarantines and travel bans have shuttered the global economy.

The world had been consuming about 100 million barrels of oil a day. Now, this week, Goldman Sachs estimated that global oil demand could drop by four to 10 million barrels a day over the next few months — the biggest contraction in the commodity’s 150 year old history.

At the same time Russia and Saudi Arabia, the world’s two major exporters, have started to flood the market with cheap oil during an historic oil glut.

The price war began when Saudi Arabia asked Russia to lower production to stabilize oil prices that were already falling due to dramatic reductions in Chinese oil demand because of its COVID-19 outbreak.

Last year China accounted for 80 per cent of growth in global oil demand.

When Russia refused to limit exports, Saudi Arabia decided that it would flood the market too.

Both petro states hope to cripple the U.S. shale fracking industry, which was already heavily indebted and cash poor prior to the pandemic.

“Any large political power sometimes needs to remind its adversaries and competitors of its might. We believe Saudi Arabia seeks to teach the market a lesson,” explained Bjørnar Tonhaugen, director of oil markets at Norway-based Rystad Energy.

The Norwegian oil think tank also predicts that global oil demand could decrease by 2.8 percent or by nearly three million barrels a day.

Although Russia, Saudi Arabia and the United States have the resources to endure a lengthy price war, all could suffer profound economic shocks as a consequence.

“If oil remains under $60 per barrel,” notes the Gobal Policy Journal, “the Russian economy could shrink by as much as 4.5 per cent this year.”

Alberta loses nearly a million dollars a day for every one dollar drop in the price of oil.

“Saudi Arabia has repeated the blunder it made in November 2014 by increasing oil production during an oil-price collapse,” noted analyst Art Berman on March 17.

“In 2014, it led to a depression in the oil industry. This time, it may be the tipping point for a global economic depression,” warned Berman on his website.

A global recession could mean a long period of low oil prices — a development that could bankrupt most of the world’s petro states.

The outlook for Alberta’s oil patch

Peter Tertzakian, executive director of the Calgary-based ARC Energy Research Institute, noted in the National Post last week that Canadian oil producers can break even with oil prices in the high US$30 range.

Below that level “about half the companies can’t pay their bills and half are treading water.”

David Hughes, an independent energy analyst, told the Tyee that companies such as Suncor who have paid off their initial investments and own their own upgraders and refineries, could survive prices as low as $20.

After the 2014 price collapse the oil sands industry, dominated by five major companies, retrenched and became much leaner. It reduced costs, automated jobs and cut stuff.

“Most of the industry can survive the downturn provided it does not last more than a couple of months,” said Hughes.

But the shale frackers operating in Alberta and B.C. already are in trouble due to high costs, low returns and crippling debt.

“They need prices about $50 a barrel to break even,” said Hughes.

“The coronavirus is a wild card. A train wreck is certainly shaping up,” added Hughes.

In the coming weeks the price collapse will contaminate other commodities and currencies because oil underpins the production of almost every substantive good on the planet.

The International Energy Agency says global oil markets now face “extraordinary uncertainty.”

Wait, isn’t cheap energy good for consumers?

In characteristic bluster U.S. President Donald Trump tweeted that “Saudi Arabia and Russia are arguing over the price and flow of oil. That, and the Fake News, is the reason for the market drop!”

He added that the price collapse is “Good for the consumer, gasoline prices coming down!”

But cheap oil creates its own set of challenges. It defeats carbon taxes and actually encourages energy spending.

And it makes it impossible for petro states such as Alberta to correct costly mistakes such as massive unfunded billion dollar liabilities for orphaned and inactive wells.

The commodity’s price volatility actively destabilizes the global economy, notes actuary Gail Tverberg.

“We can’t seem to get oil supply and demand in balance,” she recently noted in her blog. “If prices are high, oil companies can extract a lot of oil, but consumers can’t afford the products that use it, such as homes and cars; if oil prices are low, oil companies try to continue to extract oil, but soon develop financial problems.”

The current price free-fall stands to clobber petroleum exporters with higher break even prices such as Alberta and the United States.

Premier Jason Kenney has already told Albertans to prepare for “profound adversity.”

The price collapse, which could last half a year, will also create a fiscal crisis for the world’s smaller petro states including Ecuador, Nigeria, Mexico, Algeria, Kazakhstan and Iraq.

These regimes could see a 50 to 85 per cent drop in critical revenue. Nigeria, just like Alberta, needed oil prices of $57 to run its budget.

Oil markets were already showing signs of fragility and dysfunction — just like the globe’s financial system — prior to the pandemic.

A recent surge in Canadian oil sands production and U.S. shale oil production helped to drop global prices in 2014. Yet both unconventional products cost much more to extract, deliver diminishing returns and require more debt financing.

Meanwhile declining growth in the Chinese economy combined with increased production from countries such as Iran had already rattled markets, as reflected in wild price volatility.

Rocky politics ahead

Political instability generally follows low oil prices in petro states.

In Alaska, for example, citizens are now trying to recall a governor because of the way he has dealt with a budget crisis created by the state’s declining oil revenues.

When Governor Mike Dunleavy broke his election promises to “make Alaska great again” and slashed funding for the University of Alaska and even ferries, citizens revolted and launched a movement to recall the Trump supporter.

Analyst Berman suspects that the price collapse may be a tipping point for the global economy.

“We have developed an economic system that values economic growth above all else. Oil, more than any other factor, has super-charged our economic growth over the last century,” he noted.

There is a key link between shifting oil markets and how the global equity markets operate, he said.

“When growth began to slow as oil became more expensive, we turned to debt, a call on some future energy surplus. The financial collapse of 2008 was a signal that we needed to de-leverage our debt. Instead, we devised clever ways of papering over the debt problem with more debt.”  [Tyee]

Andrew Nikiforuk

Andrew Nikiforuk has been writing about the oil and gas industry for nearly 20 years and cares deeply about accuracy, government accountability, and cumulative impacts. He has won seven National Magazine Awards for his journalism since 1989 and top honours for investigative writing from the Association of Canadian Journalists.

Andrew has also published several books. The dramatic, Alberta-based Saboteurs: Wiebo Ludwig’s War Against Big Oil, won the Governor General's Award for Non-Fiction in 2002. Pandemonium, which examines the impact of global trade on disease exchanges, received widespread national acclaim. The Tar Sands: Dirty Oil and the Future of the Continent, which considers the world’s largest energy project, was a national bestseller and won the 2009 Rachel Carson Environment Book Award and was listed as a finalist for the Grantham Prize for Excellence In Reporting on the Environment. Andrew's latest book, Empire of the Beetle, a startling look at pine beetles and the world’s most powerful landscape changer, was nominated for the Governor General’s award for Non-Fiction in 2011.

Tags: coronavirus, economic contraction, falling oil prices, petro states