Victor McFarland: Oil Prices and the Pandemic

Victor McFarland

The last two months have brought enormous changes to the global oil market. The COVID-19 pandemic has led to a collapse in demand, sending prices crashing and causing severe hardship for oil producers. For a brief period, one important measure of oil prices even went negative for the first time in history.


Why have prices fallen so far?

Consumers are using much less oil during the outbreak. The biggest impact has been on air travel. Government officials have discouraged many trips, while others have been canceled by Americans fearful of infection. The latest figures from the U.S. Energy Information Administration (EIA) show a 62% decline in demand for jet fuel through mid-April.

Consumption of other fuels has collapsed, too, if not quite as dramatically. The EIA calculates that gasoline demand is down about 40% as Americans cut back on driving. Demand for distillate fuels (the most important being diesel) has been steadier. Even so, distillate fuel consumption is now down about 20%, as Americans spend less, and fewer goods are shipped by truck. In total, U.S. consumption of all petroleum products has fallen more than 30%.

The United States is not alone. Global oil consumption has fallen by roughly the same proportion as U.S. consumption – about 30% of pre-crisis demand, which was running at around 100 million barrels per day.

The collapse in demand was exacerbated by Saudi Arabia’s decision to boost production in mid-March. Saudi Arabia and the other members of the Organization of the Petroleum Exporting Countries (OPEC) knew that oil consumption was in steep decline. They had been negotiating with Russia, another key exporter, to restrain production. For several weeks, though, Riyadh and Moscow failed to agree on further cuts to stabilize the market during the pandemic. Neither country was eager to sacrifice too much of its own production, with Russia being especially resistant. Vladimir Putin’s government reportedly worried that cutting exports would just leave more of the market to U.S. companies that produce oil using hydraulic fracturing (or “fracking”). In response, Saudi Arabia opened the taps and tried to claim as much market share as it could – even if that meant lower prices for everyone.

In mid-April, OPEC and Russia (who, along with several other countries, make up the so-called “OPEC+” alliance) finally resolved their dispute and agreed – with diplomatic encouragement from the Trump administration – to cut their production by roughly 10 million barrels per day. That, however, was only about one-third of the level necessary to counterbalance the collapse in demand. It also came too late to stop a wave of Saudi exports from swamping the market.

The crash was so dramatic that on April 20, one measure of U.S. oil prices fell below zero. Oil traders had to pay buyers more than $37 per barrel to take unwanted supplies off their hands. That startling figure was, in part, merely a temporary quirk of the way that oil futures are priced. A large batch of delivery contracts was set to expire on April 21, and traders had to unload their oil quickly (for a brief, cogent explanation of the crash and its consequences, see this piece by Emily Meierding of the Naval Postgraduate School). Prices soon rose back into positive territory. Nevertheless, the collapse signaled just how badly COVID-19 had disrupted the oil market. At the time of writing, U.S. oil prices are less than $20 per barrel, down more than half from earlier this year.


What does the price collapse mean for producers?

Oil sellers are now facing very hard times. The members of OPEC, along with other exporters like Russia, depend on oil to fund their government spending. The wealthiest producers, like the Arab states of the Persian Gulf, are seeing their budgets plunge deep into the red. They, however, also have large financial reserves that should see them through at least the next two or three years – and perhaps longer, if they can cut their expenses and find new sources of revenue. Other oil producers, like Iraq or Nigeria, have much less to spare, and are far more vulnerable in the short term (as Prof. Meierding and Jeff Colgan of Brown University have noted).

The world’s largest oil producer is the United States. However, American oil companies, including ones that specialize in fracking, have higher costs than many of their overseas competitors. The current bust means that many of those companies are far from breaking even. The result is plugged wells, lost jobs, and severe economic disruption for parts of the country that specialize in oil production. Texas, for example, is facing a daunting challenge, with oil companies scaling back or shutting down their operations completely. That blow has magnified the direct impact of the pandemic, which was already throwing many Texans out of work. The same is true of other oil-producing states like Alaska and North Dakota. The ripple effects, including losses for banks that loaned money to oil companies that may now go under, could reach the entire country.


What does the price collapse mean for consumers?

At first glance, low prices seem to be great news for consumers. The most obvious sign is cheap gasoline. In Columbia, Missouri, the home of MU, gas is around $1.20-1.30 per gallon. Those are the lowest prices we’ve seen in years. Cheap energy has often boosted the U.S. economy by increasing the spending power of American consumers (for the historical link between energy prices and U.S. economic growth, see the work of James D. Hamilton at UCSD).

In 2020, however, that relationship is less solid than it used to be. For one thing, many Americans have curtailed their driving and air travel so much that they will see little immediate savings even as prices plunge. As noted above, U.S. oil production has also grown over the last decade. The United States imports less oil than it once did, and so it will not benefit as much from low prices.

Our home state of Missouri is not a major oil producer. It is, however, one of the most important corn-growing regions of the United States. Almost 40% of U.S. corn production is used to make ethanol for blending with gasoline. As a result, the decline in gasoline demand could translate into lower prices for Missouri’s farmers. Corn futures are down about 20% since the beginning of March, so we may be seeing that impact already (a connection noted by Adam Tooze at Columbia University). That’s a reminder that although states like Texas will feel the biggest impact of the price collapse, we can’t neatly divide U.S. states into oil producers and oil consumers. Energy supply networks are so deeply interwoven into the American economy that changes in oil prices can have complicated and unexpected effects.


Are there historical precedents for this situation?

The world has never seen a pandemic-driven oil price collapse of this speed and scale. Earlier outbreaks, like the influenza pandemics of 1918, 1957, and 1968, or the smaller SARS outbreak of 2003, disrupted economic activity but did not shut down travel worldwide. Late April’s negative oil prices were also unprecedented.

In a broader sense, though, the oil industry has long been known for extreme volatility. It was infamous for spectacular booms and busts as early as the mid-19th century. Robert McNally’s book Crude Volatility provides an accessible introduction to the industry’s history of sudden price swings.

The situation in March and April of this year, when demand slumped just as Saudi Arabia increased production, bears some resemblance to several previous times when oil prices collapsed. They include the early 1930s, when huge new discoveries in Texas coincided with the Great Depression and a massive slump in demand; 1985-86, when a worldwide glut of oil led to an intra-OPEC price war; and 2014, when Saudi Arabia decided to keep production up, even as the U.S. fracking boom (and the lingering weakness of the global economy after the 2007-08 financial crisis) cut demand for Saudi exports. Periods of greater price stability included the turn of the 20th century, when the market was dominated by John D. Rockefeller’s Standard Oil trust, and the mid-20th century, when the world’s biggest oil companies (the so-called “Seven Sisters”) colluded to limit competition between themselves. Those periods, though, were more the exception than the rule. Even OPEC during its heyday of the 1970s was a troubled institution, with no ability to enforce production cuts and intense disagreements between its member states (for more on that history, see the work of Prof. Colgan and Giuliano Garavini at Roma Tre University).


Where do we go from here?

There is no longer any producer (or even group of producers) like Standard Oil or the Seven Sisters powerful enough to control the oil market. OPEC cannot restore the prices that prevailed before the pandemic. The shutdown of fracking wells, if many American oil companies scale back their operations or go bankrupt, could bring supply and demand into somewhat greater balance. A real recovery in prices, however, is unlikely without a resumption of economic activity both in the United States and around the world. That will not happen overnight.

The slump is likely to last at least through this summer. After that, much depends on the medical response to the pandemic. If an effective antiviral treatment is discovered, or a vaccine is ready for limited use by the end of this year (the most optimistic timeline), people might feel confident enough that travel will start to recover rapidly. If the virus is still causing sickness on a large scale in 2021, or even later, the oil bust could last for a long time. Boeing, for example, has predicted that it will be three years before air travel again reaches its pre-pandemic level. If many in-person meetings and conferences are permanently replaced with telework, a good deal of demand for jet fuel and gasoline could be eliminated altogether.

Climate change is another important factor. Before the pandemic, oil industry observers were already debating whether the world had reached peak oil demand because of greater energy efficiency, new technologies like electric cars, and government policies to limit greenhouse gas emissions. The impact of COVID-19 on that front isn’t yet clear. In the short term, some environmentalists and climate change activists have looked for a silver lining to the pandemic. They note that with the decline in fossil fuel use, people are enjoying cleaner air from Los Angeles to New Delhi to Beijing, and global warming has been slowed.

Without deliberate policy interventions, however, that change will be temporary. Cheap oil might even encourage consumers to buy larger vehicles and travel more, as soon as they emerge from their homes and start spending again. And in their eagerness to stimulate economic growth, some governments could de-prioritize environmental concerns. China, for example, has already delayed the implementation of tighter emissions controls on new vehicles, allowing more polluting vehicles to be sold, even as it simultaneously extends subsidies on electric cars.

Five months ago, no one would have imagined that the zoonotic potential of bat coronaviruses, or the efficacy of experimental drugs like remdesivir, would be critical for predicting the future of the global oil market. This crisis is a reminder that no aspect of human affairs – from science to politics to economics – is separate from the others.

That makes me grateful that I study history. Historians don’t need to look at politics, economics, science, culture, or any other subject on its own. They can explore how all those things intersect, in a way that’s impossible when you’re caught in the middle of events too complicated for any one person, or discipline, to understand on their own.

Telling the story of the COVID-19 pandemic will be a daunting challenge for future generations. Some historians will write about how scientists finally found a vaccine that worked, while others will write about the experience of social distancing, the rise of Zoom meetings, the human impact of the jobs lost when so many businesses shut down, the turmoil in the oil market, and the new economy that emerged after the virus went into retreat.

Those scholars will know how it all turned out. We don’t – not yet. But in the meantime, if we want to understand the situation we’re in, we could do worse than starting with the study of history.


Victor McFarland is an assistant professor of history at the University of Missouri. He studies energy, the environment, and U.S. relations with the Middle East. His first book Oil Powers: A History of the U.S.-Saudi Alliance is coming out in June with Columbia University Press.