Why Big Oil is paying top dollar to dump its fossil fuel – and what that means for renewables

Australians are used to negative energy prices. It used to happen a lot at nighttime when there was too much coal power, so they shifted the timing of hot water systems to the middle of the night. The huge growth of wind and solar is now causing negative prices in the middle of the day, sending a market signal for energy storage and for more daytime manufacturing.

But the world had never seen negative oil prices, until the global oil market crash-landed in uncharted territory this week when the cost of the fossil fuel in the US went into negative territory and forced companies to pay up to $US36 ($A57) a barrel just to have it taken off their hands.

The unprecedented situation is the latest headline-grabbing consequence of the Covid-19 pandemic, which has seen entire airlines grounded, ships docked and fleets of cars retired to garages for the duration of government-mandated lock-downs that aim to keep the new virus in check.

The pandemic has reduced global demand for oil by about 29 million barrels a day, from about 100 million a year ago. Meanwhile, cuts in production agreed to by OPEC and other producers – and supposedly brokered by Donald Trump – have come to little, leaving a huge surplus on the market and no buyers.

As a result, on Monday, prices for West Texas Intermediate crude – the main benchmark for US pricing – plunged to negative $US36.20 a barrel. Prices for Alberta crude oil (the benchmark in Canada) also “went negative,” but only in the sense that the benchmark price went lower than the cost of production, transport and storage.

As Market Insider explains, this is a phenomenon known as contango, which sounds like a Latin dance but is where futures prices are higher than spot prices. It is a signal of a combination of oversupply and weak demand – but with the added peculiarities of oil market trading thrown in for good measure.

“It’s like trying to explain something that is unprecedented and seemingly unreal!,” said Rystad Energy oil markets analyst Louise Dickson in comments on Tuesday.

“The most simple explanation for negative oil prices is that midstream players are now paying ‘buyers’ to take oil volumes away as the physical storage limit will be reached. And they are paying top dollar!

“Traders have been gobbling up cheap oil and pumping storage full, and now, in the case of WTI and Cushing, storage has reached a physical limit – we estimated earlier today that there was only 21 million barrels of free storage left.”

Rory Johnson, managing director and market economist at Price Street, was quoted as describing the plunging future price as a “hot potato” being passed around between traders.

Whoever gets stuck with the hot potato “will be stuck with thousand of barrels of physical oil and nowhere to put it, which will get expensive very quickly,” he said.

As Dickson notes, none of this should be news to anyone trading oil – Rystad and many other agencies have been warning about running out of storage in mid-May.

“This is the inevitable progression of a world where demand destruction is ubiquitous yet temporary,” said Daniel Gerard, senior multi asset strategist at State Street Global Markets.

“Steep contango puts additional pressure on the search for storage in excess of the supply that was already looking for a home as demand collapses.”

And like the Coronavirus itself, the situation doesn’t look like resolving any time soon.

“This storage crisis is not going away for at least a few months which means we will continue to see volatility with spot futures, and rolls,” Gerard said.

“Barring a grand agreement from Saudi Arabia, Russia and Texas, which seems highly unlikely, current dynamics and low oil prices will persist. We see very low prices through the rest of 2020 at a minimum.”

“If you are a producer, your market has disappeared, and if you don’t have access to storage you are out of luck,” said Aaron Brady, vice president for energy oil market services at IHS Markit, a research and consulting firm. “The system is seizing up.”

So what does this mean for the rest of us? Well, first of all, don’t expect to be paid to fill up your car. As GasBuddy analyst Patrick De Haan Tweeted, it just doesn’t work that way.

While negative oil prices will flow through to cheaper petrol at the bowser, they won’t provide all that much relief, particularly considering how few are currently making the daily commute. Further, as Axios notes here,  economists would warn that the lower prices are at one point, the higher they will be at some point in the future. So cheap petrol is by no means the new norm.

As for the implications for the global climate effort, and the transition to renewable energy, plunging oil prices aren’t great news in that department, either.

Not only is the oil crisis a major political distraction from the task at hand – as demonstrated by Australia’s fossil-fuel inclined federal energy minister this week – but negatively priced oil is likely to be a speed-hump to progress on decarbonisation.

Happily, the increasingly low cost of generating renewable energy from solar and wind has on its own undercut fossil fuels on almost every measure. But a sustained hit to global oil prices will serve to make the fossil fuel more competitive against low-carbon alternatives. And even if that boost is artificial and short-lived, it is a blow to the urgent task of cutting emissions.

As the ANU’s Chris Downie explained here last month, the ups and downs of the oil market should be seen as a side-show to the main renewable energy game.

“Australian energy diplomacy needs to quickly come to grips with the rapid deployment of renewables upending global energy markets,” Downie said.

“Electrifying our transport sector is likely the best way Australia can improve its oil security – think policies to increase the uptake of electric vehicles – not by relying on oil reserves on the other side of the Pacific.”

For Big Oil, says Fortune, the Coronavirus effect could hurry along the industry’s shift to greener pastures.

“Long before this spring’s epic oil-price crash, the energy sector was struggling with a longer-term existential threat,” writes Jeffrey Ball.

“A scary new world had arrived, one in which oil demand was projected to peak in the next couple of decades even as external pressure surged – not just from environmental activists and regulators, but also from central banks and hedge funds – for Big Oil to diversify into lower-carbon energy sources.

“That pressure already had begun to reshape the industry’s business strategy. This week’s energy-market carnage shows every sign of intensifying that low-carbon shift.”

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