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By Nick Reynolds
Casper Star-Tribune Via Wyoming News Exchange 

Gordon: 'Everyone in Wyoming should be concerned' by dip in oil prices

 

April 16, 2020



CASPER — Futures prices for oil fell into the negatives for the first time in recorded history Monday, further straining a Wyoming economy already reeling from months of price declines, continuing strife in the coal industry and the shutdown of numerous businesses due to the COVID-19 pandemic.

West Texas Intermediate oil contracts for the month of May plunged nearly 300 percent to nearly negative $38 per barrel ahead of Tuesday’s expiration date to purchase May contracts — one of the largest price drops in history.

Prices are likely to rebound on Tuesday when trading begins for the month of June. (June prices are already trading at around $21 a barrel — slightly above the $18 per barrel prices seen last Friday.)

But the unprecedented decline is a symptom of continuing downturns created from an ongoing price war between Organization of the Petroleum Exporting Countries and Saudi Arabian oil producers that, since kicking off earlier this spring, has caused precipitous drops in oil prices around the globe.

The 2021 fiscal year is already three-quarters of the way through, with fair trading oil during most of that span — meaning immediate impacts to Wyoming will be somewhat muted.

But the world has changed substantially in the last seven weeks, University of Wyoming economist Robert Godby said, challenging assumptions that, just months ago, could have been seen as safe bets.

While overproduction on both sides of the ocean has flooded oil markets, driving down prices, the COVID-19 pandemic has, in concert, destroyed demand for that oil, with fewer people driving their cars, traveling on cruise ships or flying on planes. Those two factors have created a collision in the market that — combined with the nature of commodities trading — essentially amounts to a train wreck for oil prices.

“This is a very rare occurrence that is really only occurring because of a structure of market contracts and the timing of futures contracts,” Godby said.

How did this happen? Monday’s prices — while expected to be a short-term event — are a reflection of what happens when an extraordinary and quickly evolving economic event collides with a slow response in commodity-based supply chains, which are often traded based on a product’s future performance in order to restrain volatility.

There are two ways to trade oil. One is to be a speculator, someone who thinks oil prices are going to go up and, therefore, buys a futures contract that allows them to lock themselves in at a low price and eventually sell that oil at a profit.

If you’re an oil producer, however, you may buy a contract that will lock in your future oil price in order to reduce the uncertainty for future price declines, a sort of risk management tool to prevent instantaneous collapses in price.

“Most people who are trading oil futures are not so much speculators but people doing risk management,” said Clark Williams-Derry, a senior fellow at the Sightline Institute. Monday’s negative price environment, with that understanding, was the result of an unprecedented environment where demand was extremely low, supply was very high and optimism the market would correct itself by the end of May was minimal.

Ultimately, this meant that contract prices on Monday — the last day speculators could trade May delivery crude — were priced at a level where it would be less expensive for producers to pay someone to take the oil off their hands than it would be to build more storage or shut down their wells, which could potentially spoil their chances to make future profits.

“There’s so much going on down that borehole that you have to have a real careful understanding of what’s going to happen if you change anything down there,” said Pete Obermueller, the executive director of the Petroleum Association of Wyoming. “You could ruin a reservoir if you don’t know what you’re doing. It takes some time to do that.”

“You can’t just say ‘Oh, prices are bad, let’s flip a switch,’” he added.

While producers across Wyoming have cut production, with the number of drilling rigs across the state down from 35 in September to just six today, production cannot simply cease overnight, meaning the only option left for U.S. producers is increasing storage capacity — something President Donald Trump announced Tuesday could be happening in the coming weeks.

However, sustained conditions like these, as well as the uncertainty around when economies around the world will begin to recover from the COVID-19 pandemic, will likely lead to continued underperformance for the state’s producers.

“The big reason why it was negative today was that people needed to get out of the position of having to take delivery, because they didn’t know where to put (the oil) due to the storage problem,” Obermueller said. “I don’t know how — absent the federal government moving quicker to open up the Strategic Petroleum Reserve and some sort of snap back in demand — we will alleviate those problems by the June market deadline.”

What does this mean for Wyoming? The price war has had an outsize effect on Wyoming’s economy, which was already under barrage from declines in coal production due to a once-in-a-lifetime pandemic that has produced record-high levels of unemployment statewide.

The city of Cheyenne, citing declines in the energy sector as well as from sales tax losses tied to COVID-19, cut 17 positions last week just days after Gov. Mark Gordon released a letter asking state agencies to identify ways to reduce their budgets in response to declining revenues.

Long term, the numbers already looked grim: Prior to Monday’s announcement, tentative revenue projections released by the Legislative Service Office on April 10 already projected revenues to fall anywhere from $555.8 million to nearly $2.8 billion over the coming biennium, with the most pessimistic scenario anticipating oil trading at $35 a barrel over that time span.

Even though oil prices will inevitably see a jump Tuesday, the current June contract WTI prices of just about $20 per barrel are the lowest seen since 1998, said Wenlin Liu, an economist with the Wyoming Department of Administration and Information’s Economic Analysis Division.

While this means less direct severance tax revenue from oil production (every 20 million barrel reduction in production means $12 million less revenue per month, Liu said in an email), it also means declines in sales tax revenue from industries related to drilling and the loss of numerous high-paying jobs, which in turn means less spending power circulating in local economies.

In short: the economic impact, if sustained long-term, could be devastating.

“Everybody in Wyoming should be concerned about this,” Gordon said in a statement to the Star-Tribune. “It’s going to impact the livelihoods of our friends and neighbors. It also underpins why we need to get the country back to work in a manner that is as safe as possible.”

Meanwhile, the Wyoming Legislature is likely limited in its response. In recent weeks, several state lawmakers have raised the possibility of introducing legislation that could put the state’s energy sector on a “glidepath” to help hedge the worst impacts of the current crisis.

Economist and Senate Revenue Committee Chairman Cale Case, R-Lander, however, said that the state’s tax policy — at this juncture — stands little chance against global market forces.

“We’re price takers in the market,” he said. “We deal in commodities, and when you do that, you sell to a market; you don’t dictate the prices. There are people in the Legislature who think we need to cut taxes more for industry, but I don’t think that’s the right solution.” “We need to ride this out, basically,” he added.

 
 

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