The pandemic-induced collapse in crude oil demand and the resulting negative pricing for May U.S. futures contracts could be more than a temporary phenomenon. Rather, it could be a sea change in the world’s economies, presaging and perhaps bringing on a period of deflationary pressures.
That’s a scary scenario, as deflation – reducing of prices across the board – was the most pernicious characteristic of the 1930’s Great Depression. Congress, a conflicted Trump administration (which clearly wanted low world oil prices to benefit U.S. consumers and high prices to benefit U.S. oil producers), and the Federal Reserve have noted the threat of deflation, taking extraordinary, multi-billion dollar steps to inflate a deflating economy.
New York Times economics columnist Neil Irwin wrote this week that “the broader takeaway is that the Covid-19 crisis is an extraordinary deflationary shock to the economy, causing the idling of a vast share of the world’s productive resources. Don’t let shortages of a few goods, like face masks or toilet paper, confuse the matter. The consequences will almost surely persist beyond the period of widespread lockdowns.”
The oil futures market is also a classic demonstration of what we all presumably learned in Econ. 101 in college: price is a function of supply and demand in competitive markets. In the oil market, thanks to, initially, a stupid and ruinous price war between Saudi Arabia and Russia, and then the crashing of demand from social distancing and economic collapse around the globe, supply, and the glut of oil in storage coupled with the anemic demand, means prices have fallen far through the floor.
Irwin warns of a “deflationary collapse – a glut of supply of good and services, and consequently falling prices – that surpasses anything seen in most people’s lifetime.”
The Trump administration is responding with a plan to bail out U.S. oil producers. As OilPrice.com reported, Trump tweeted today, “We will never let the great U.S. Oil & Gas Industry down. I have instructed the Secretary of Energy and Secretary of the Treasury to formulate a plan which will make funds available so that these very important companies and jobs will be secured long into the future!” The tweet came after Monday’s May benchmark futures contract crashed down to -$37.63/barrel.
Will the Trump bailout work? It’s unlikely, as the oil price collapse appears more far reaching and more fundamental that the administration can manipulate. The peace treaty between the Saudis and the Russians (OPEC+) is unlikely to relieve the market glut, given the low energy demand.
Nor are the prospects for a market rebound any better looking ahead. Chirag Rathi of Frost & Sullivan commented today, “The series of events that have unraveled in the last 24 hours have made it clear that futures contract turning negative is not a technical trading blip, as the COVID-19 contagion has spilled over to [West Texas Intermediate] June 2020 deliveries as well. It is clear that the storage is just as full for June, as it is for May. Already Cushing [Oklahoma, a major storage center] is near capacity and is effectively closing for further business. The OPEC+ which had the US tight oil in its sights for nearly a decade, cannot celebrate the Pyrrhic victory in the short term, as the other global benchmark follow the WTI decline. Even in the most effective containment scenarios, we are looking at a substantial cut in the US shale production, allowing the OPEC+ to regain the market share it lost to shale in the last decade.”
Hold on tight. When the world begins to recover from the coronavirus, it looks like the global economy will be considerably weakened, deflation may be rampant, and another Great Depression ahead.
— Kennedy Maize