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June 1, 2020

The Oil Market’s Lazarus Effect

By Robert Dillon and Martin Jirušek

The death of the oil age has oft been predicted. Peak supply. Peak demand. Peak shale.  

Barely two months ago, oil markets were in disarray because of the combined supply and demand shocks of the price war and unprecedented government responses to the coronavirus pandemic that resulted in the near-complete shutdown of national economies around the world.  

On March 18, U.S. benchmark West Texas Intermediate (WTI) had its third-worst day ever, hitting an 18-year low after falling more than 24 percent.   

And one month ago, WTI plunged into negative price territory for the first time in its history as traders tried desperately to shed future contracts before their delivery date came due. For a brief moment, traders paid nearly $40 a barrel to have oil hauled away rather than face the prospect of taking physical ownership of a commodity no one wanted.   

Anti-oil forces in the United States and Europe cheered the end of the oil era and said the price collapse signaled a turning point for climate change.  

Fatih Birol, head of the International Energy Agency (IEA), called it “Black April” and said 2020 would go down as the worst year in the history of the oil industry.  

A month on and oil prices have rebounded. Analysts are now scrambling to revise production and price forecasts upward to accommodate a surprising recovery in demand for a commodity that, like it or not, on which the world remains dependent.  

The end is often further off than we imagine.  

The IEA, which predicted global oil demand to shrink by 11 million barrels a day this year, has downgraded its demand destruction forecast to 8.6 million barrels a day as demand for petroleum comes back more robust than expected.   

The ultimate robustness of the recovery remains an open question, especially if another wave of COVID-19 cases hit in the fall. But oil markets, for now, are on the mend. 

The demand collapse bottomed out in mid-April at an astounding, but temporary, 72 million barrels a day.  

Average global demand for the year is expected to be 89 million barrels a day, a drop of just 10 percent from last year, according to Rystad Energy. In Europe, that figure is around 12 percent, and demand is expected to fall by about 11 percent in the United States. Demand in China, the world’s second-largest oil-market, is already back to pre-pandemic days as the country reopens and manufacturing centers resume output. Bloomberg reports China is consuming about 13 million barrels a day at the moment.  

If demand around the world follows China’s example, the global recovery is off to a more energetic than anticipated start. Some estimates peg demand returning to the 100-million barrels a day level by next year—a genuinely remarkable reversal.  

Drastic production cuts by the Saudi-led Organization of Petroleum Exporting Countries (OPEC) and its allies, primarily Russia, are helping restore supply and demand balance. Still, the OPEC-plus deal is only part of the reason why prices are on the mend.  

The narrow spread between WTI and Brent prices points to another, more intriguing market driver. Producers in the United States responded independently to the market signals to shut-in wells far quicker than expected—and are showing surprising restraint even as prices rise.  

U.S. production is down about 3 million barrels a day, with Canada removing another 1 million barrels a day from the North American market. Production is set to fall further as drillers continue to shut-in less-profitable wells, and investment budgets are slashed an average 25 percent across the industry.  

The number of drilling rigs active in the U.S. onshore dropped this month to its lowest level in 80 years, and the U.S. Energy Information Administration expects production from the seven U.S. shale basins to fall another 197,000 barrels a day next month.  

The scope of the cuts could push oil prices to $50 before the year’s end. That would be good news for shale, which typically requires WTI in the mid-$40s to breakeven. But rising prices aren’t a panacea for the sector, which remains heavily leveraged, and if shut-in production returns too soon, it could stall the recovery.  

The crash has also exposed a fundamental dilemma for shale. After turning the United States into the world’s top oil and natural gas producer, unconventional tight shale remains vulnerable at low prices due to its higher production costs and steep decline curves.  

The global supply market moving forward is likely to more resemble the situation before the rise of shale when Saudi Arabia and Russia—and other national oil producers—dominated supply.  

Russia and Saudi Arabia, which have far lower production costs, could survive at Brent around $30—an amount that’s in line with EIA’s latest Short-term Energy Outlook of an average oil price of $34 this year and $48 in 2021.  

In the United States, the near-term outlook should remind many of 1998 or 2014, periods of sharp downturns and consolidation. The result is likely to be a sector dominated by larger, more risk-averse integrated companies and fewer small independents that have traditionally driven discoveries—including shale.  

January’s 13 million barrels may turn out to be the zenith of American production, but reports of oil’s death are greatly exaggerated once again.


Robert Dillon is a senior fellow for energy security at the Rainey Center and the former communications director of the U.S. Senate Energy and Natural Resources Committee. He covered the economic and social transition of the former Soviet Union as a journalist based in Prague and Moscow after the fall of the Berlin Wall.

Martin Jirušek, Ph.D., is an assistant professor at the Faculty of Social Studies, Masaryk University, focusing on energy security in post-communist Europe and the transatlantic dimension of energy security. 

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