Oil and Gas

Could Crude Oil Prices Drop to $5 per Barrel?

In sports, a “head fake” is when a player moves their head to deceive an opponent regarding their direction of movement.

But a head fake can also happen in the stock market. That’s when a move in the market or a stock is quickly followed by a move in the opposite direction.

The market has had quite a few head fakes in recent weeks. And there will probably be more to come, especially in the oil industry.

Is This for Real?

Last week, President Trump indicated he was working on a deal to get Russia and Saudi Arabia to cut oil production by 10 million to 15 million barrels per day. Oil prices and oil sector stocks soared after this news.

WTI and Brent crude then posted their biggest weekly percentage gains ever…
WTI Trade Performance Chart
But will oil continue higher? I don’t believe so.

Even if Saudi Arabia and Russia strike a deal, there are other factors at play here.

For example, global oil markets are facing unprecedented headwinds. Demand has dropped through the floor.

Why? Because hardly anyone is driving around these days.

Empty Roads

Our car has been in the garage for nearly two weeks. My wife, who is a teacher, normally uses it to commute to school every day.

She’s been told she’s more than likely going to be teaching from home for the rest of the school year. My son is also not working through at least the end of the month and maybe longer.

Multiply these two examples by 100 million or so, and you can see the impact this is having on the U.S. economy.

The prolonged isolation and social distancing continue to deal a massive blow to oil demand.

But that’s just the beginning. Almost in sync with the appearance of COVID-19, Saudi Arabia announced it was going to start massively overproducing crude.

The kingdom is feuding with Russia. President Putin blames Saudi Arabia for the collapse and won’t agree to cut production further.

So Saudi Arabia decided to turn on the spigots.

Those two events alone are enough to crater oil prices. But there’s more to this perfect storm.

Two weeks ago, the U.S. had the second-largest buildup in crude oil inventories in its history, according to the Energy Information Administration. That’s a big problem.

We desperately need coordinated, global cuts in crude production. Otherwise, global storage will run out by late June.

If that happens, oil prices will collapse even further.

The Biggest Hit

Texas’ Permian Basin is the crown jewel of U.S. shale oil production right now. But it may take the biggest hit.

The Texas Railroad Commission (TRC) oversees fossil fuel production in the Lone Star State. Like many of us, it’s conducting its meetings virtually this month.

On the agenda is a discussion of whether to order statewide production cuts. The last time it implemented cuts like these was back in the 1970s.

The TRC is beginning to see the scope of the problem. But I don’t think it will act quickly enough or cut enough production.

An End in Sight?

As I mentioned, Trump is desperately trying to broker a deal between Saudi Arabia and Russia. But at this point, it looks like it’s just wishful thinking on the part of the president.

I believe the current climate could send oil to $5 per barrel. I don’t see the U.S. or Russia changing its production momentum in the near term.

Remember, U.S. producers are still smarting from the last time Saudia Arabia boosted production four years ago. The kingdom was intent on putting U.S. shale producers out of business.

That didn’t happen. The break-even oil price for many U.S. shale producers is between $48 and $54 per barrel.

Today, WTI crude is $26.36 per barrel and heading south. So you do the math for U.S. producers…

Many U.S. shale producers are highly leveraged and saddled with mountains of debt. Their cash flows, already compromised, will nearly dry up if oil prices continue to drop.

Some are trying to solve the problem by increasing production. But ultimately, all will have to close off some wells in order to meaningfully reduce production.

Investors would be wise to avoid this sector altogether. Don’t be lured into buying into the oil patch after last week’s big jump.

It’s a classic head fake. And U.S. shale producers are going to be the big losers.

Stay safe and healthy,

Dave