Analysis

Oil Prices Go Negative For 1st Time As Slump Worsens

By Keith Goldberg
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Law360 (April 20, 2020, 7:34 PM EDT) -- U.S. oil prices plunged into negative territory Monday for the first time ever as the nation's oil storage capacity neared its limit thanks to a historic coronavirus-induced demand slump, a tipping point experts say could turbocharge the growing wave of driller bankruptcies.

The price of a U.S futures contract for delivery of crude oil in May fell as low as -$40 a barrel Monday, which means producers would have to pay someone to take the oil off their hands. While the unprecedented price collapse can be partially explained by the fact that the futures contract for May delivery expires Tuesday, it speaks to a more stubborn issue: The COVID-19 pandemic has slashed demand for oil so much that U.S. storage capacity is filling to the brim. That means the oil that's still being pulled from the ground will have nowhere to go.

Oil and gas industry watchers say Monday's price plunge foreshadows a bloodletting for scores of companies and will heap more pressure on state oil regulators to order drillers to curtail their production.

Driller bankruptcies are already on the rise, and many experts were expecting the pace to accelerate as the drop in demand took hold. Negative oil prices will simply paralyze drillers that at the very least need to produce enough cash to service their debt, experts say.

Expect a fresh wave of driller bankruptcies over the next few weeks, said Winston & Strawn LLP oil and gas partner Mike Blankenship.

"They're going to have no cash flow to service their debt, so they're going to have to restructure," Blankenship said. "I think financial institutions are going to get spooked by this and force defaults under their credit agreements."

In fact, drillers' hedges, where a counterparty agrees to buy a percentage of anticipated future oil production at a certain price for a certain period of time, may be one of the only things keeping many drillers afloat, experts say.

Many producers have hedged significant amounts of their production at prices above where oil is currently priced, and negative prices mean that pot of cash for drillers is larger than ever. While companies could agree to unwind those hedges, take the cash in one shot and use the money to immediately pay down a chunk of their debt, experts say it might behoove them to keep the hedges in place for a longer period to preserve some semblance of steady cash flow.

"If prices drop low, the producers receiving that hedged payment helps them make their debt service on the loan," said Jackson Walker LLP partner Jesse Lotay, who focuses on energy-based commodities work. "That's exactly what hedging is designed to do."

Monday's price collapse came a day before the Railroad Commission of Texas, which regulates the oil and gas industry, could decide whether to vote on a potential statewide curtailment of oil production for the first time in nearly five decades.

Texas shale giants Pioneer Natural Resources USA Inc. and Parsley Energy Inc. want the RRC to start a statewide proration of oil production as early as next month in which Lone Star state drillers would have to reduce a percentage of their total production in order to align it with market demand. The agency hasn't ordered proration since 1973, and in a lengthy public meeting on the petition last week, RRC commissioners questioned whether the state's drillers are in dire enough straits to order proration.

"It is going to put pressure on how they prorate in Texas, or if they prorate," Blankenship said.

Futures contracts for U.S. crude oil delivery in June and subsequent months are in the $20-a-barrel range, suggesting that at the moment, prices have bottomed out. But Steve Craig, chief energy analyst at financial analysis firm Elliott Wave International, said that would only amount to a correction in a long-standing bear market for oil.

"Nobody in their right mind would have forecasted a subzero number, but the bear market was still in force," Craig said.

"We're in the late stages of this last leg of the decline, but that corrective advance is in a bear market," he said.

Experts say the current prices for futures contracts in June and subsequent months make big assumptions, including that a U.S. economy largely shuttered because of COVID-19 is going to open up significantly within the next few weeks and that regulators like the RRC are going to curtail production or drillers will otherwise drastically shut in their wells.

"Nothing is to say that 30 days from now, we're not having this conversation again," Lotay said.

--Editing by Jill Coffey and Kelly Duncan.


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