The GERM Report

-Production restraint has offered zero support for the price of oil

-Once it’s gone, it’s gone, the US energy secretary suggests.

So far, it seems the breakthrough deal among the world’s major oil producers did little to prop up the price of oil. Production restraint provides little support at a time when many segments of the global economy are shut down. According to the International Energy Agency, capital expenditures are expected to drop about 32% from last year to the lowest level in 13 years. In the US energy sector, that pressure already helped push one company into bankruptcy. The message in the market appears to be that supply matters far less than demand. As with any systemic crisis, there may be no going back.

Brent crude oil was down 4% as of 8 a.m. ET to trade at $28.41 per barrel. With the spread widening at an ever-increasing rate, West Texas Intermediate plunged into the upper teens early Wednesday. Since Thursday, and despite a much-lauded agreement among major oil producers, the global benchmark is down 13%.

The IEA in its monthly report for April predicted global oil demand would fall 9.3 million barrels per day, with this month’s retraction the largest in a quarter century. Though some major economies are considering easing isolation guidelines, the agency said the recovery will be a slow one. Demand in December could still be about 2.7 million bpd lower year-on-year. Refinery intake, meanwhile, could be low enough to force shutdowns across the globe. Even if things return to “normal,” the destruction will have erased almost a decade of growth in oil demand. In terms of the OPEC etc. agreement brokered during the weekend, the IEA said it helps, but it may have been too late.

“Even so, the implied stock build-up of 12 million bpd in the first half of the year still threatens to overwhelm the logistics of the oil industry – ships, pipelines and storage tanks – in the coming weeks,” the report read. “Also, low prices impact the livelihood of millions of people employed along the oil industry’s extensive value chain, and they damage the economies of weaker producing countries where social stability is already fragile.” 

The IEA added, however, that the response from global economic policymakers is unprecedented. Americans this week are seeing federal stimulus money show up in their bank accounts, though there are few places to spend it. The French central bank reported March retail sales plunged 24%, with the industrial goods segment showing a 43% contraction. The New York Fed on Wednesday reported its general business conditions index posted its largest drop, 57 points, in history. US retail sales for March dropped 8.7% from the previous month and 6.2% year-on-year. One beacon of optimism is US sales at food and beverage stores, up some 28% from March last year.

The demand destruction is unprecedented and the damage to the oil economy is severe. The IEA said storage levels are approaching capacity and adding a premium to the price on places to deposit excess barrels. The price to charter a VLCC, meanwhile, has more than doubled since February.

“Never before has the oil industry come this close to testing its logistics capacity to the limit,” the April report read. “Low prices threaten the stability of an industry that will remain central to the functioning of the global economy.”

Production is part of the equation, but it does not represent the entire formula. While comparisons to the Great Depression mean little in an era where banks are more resilient than ever, this is new territory. And it will mean an end to some segments of the oil economy. Speaking to Ed Crooks at Wood Mackenzie, US Energy Secretary Dan Brouillette acknowledged the destruction may be permanent.

“Some of these wells, once they shut in, they’re not coming back,” he said. “And if they don’t come back, then you’re dealing with the loss of production, obviously, and potentially you start to lose jobs at an incredibly fast pace.”