The coronavirus pandemic is hurting the world economy in some extreme ways. One of the most extreme is the distortion affecting the US market for oil. On Monday the price of American crude fell below zero for the first time in history. The reason for the one-day collapse was in part technical; amid a plunge in demand, an important one-month futures contract expired the following day. With storage running low, traders holding the derivative contract found themselves with nowhere to put the oil. The owners of supertankers are among the surprise winners of the crisis — day rates to hire the vessels and their oil tanks have jumped fivefold.
The historic low is the clearest sign yet of the depth of the economic damage being done by state-imposed lockdowns to counter the spread of the virus. Demand for oil has been cut by up to a third worldwide. Oversupply has only exacerbated the situation. The price of Brent crude, the international benchmark, dropped below $20 on Tuesday for the first time in 18 years.
The price collapse makes a mockery of President Donald Trump’s claim a week ago that he had managed to put a floor under the price after securing a deal between Saudi Arabia and Russia to cut production from next month. The deal has proven to be too little, too late. It has underlined the miscalculation by both Russia and Saudi Arabia in pursuing a price war at a time of extraordinary economic weakness. There are valid questions over how long Russia’s economy can withstand a sustained period of low oil prices.
This is no short-term price shock. Storage is likely to remain scarce for a while. Demand, too, will take time to recover; more than 40 per cent of oil demand comes from cars and trucks, many of which are at a standstill. The drop in prices is in many ways a harbinger of things to come for the energy industry. “Big Oil” was already out of favour with investors and the general public over its role in climate change. Oil demand could peak sooner than previously expected. The current rout means companies will have to accelerate restructuring plans. Long-cherished dividend payments may have to be cut. The supermajors, including BP and ExxonMobil, will have to boost spending on alternative forms of energy. The International Energy Agency noted recently the average investment by oil and gas companies in non-core areas has amounted to barely 1 per cent of total capital spending.
US oil producers, many of which expanded on the back of cheap credit, will feel the greatest pain. Mr Trump had already raised the prospect of an industry bailout, including offering storage space in the Strategic Petroleum Reserve. Mr Trump is now promising support for the industry, but this should be short-term — and with quid pro quos. Indeed, the price collapse presents an opportunity — one the US administration should grasp. At a time when consumption has all but ground to a halt, it would be an opportune time to heed longstanding calls for some form of national carbon taxation. At the very least, subsidies should have conditions attached such as stipulating that companies that receive aid must have a decarbonisation plan in place.
Artificially pushing up the oil price would normally be a bad thing for individuals and the economy but with factories closed and millions of people at home, cheap oil is hardly boosting spending power. Low prices also damage poorer producing nations. The green agenda demands a radical shift away from oil. But if production capacity is killed off too fast, the oil price could rise sharply higher, dealing the world another painful economic shock ahead of that crucial transition.
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