The decline in oil prices since the beginning of the fourth quarter of 2018 is of similar magnitude to the fourth-quarter price decline in 2014. After the fourth-quarter 2014 price decline, prices dropped further in 2015 amid high volatility for several years, which contributed to bankruptcies, consolidations, and closures within the industry. When comparing the financial positions of U.S. oil producers as of the third quarter of 2018 with the third quarter of 2014, most measures of profitability and balance sheet fitness indicate companies should be able to weather the recent price downturn. Oil price volatility and uncertainty remain high, however, and financial pressures could increase if prices continue to decline.
The percentage price decline from the beginning of the fourth quarter of 2018 through December 18 followed a similar path when compared with the same period starting at the fourth quarter of 2014 (Figure 1). From October 1 through December 18, front-month West Texas Intermediate (WTI) crude oil prices declined 39%. In 2014, they declined 40% during the same period. A key difference in assessing the financial position of U.S. oil producers in 2014 compared with 2018, however, is that oil price levels were significantly higher in the years leading up to the 2014 price declines compared with 2018. In addition, in 2014 oil prices had already declined 15% from their highs in June by the start of the fourth quarter. In 2018, the start of the fourth quarter marked the highest prices of the year.
Given the different price levels, oil company revenues per barrel were significantly lower in the third quarter of 2018 compared with the third quarter of 2014. According to the third-quarter 2018 financial results of 40 U.S. oil companies, their median upstream revenue was $45.33 per barrel of oil equivalent (BOE). This same set of companies in the third quarter of 2014 had median upstream revenues of $64.57/BOE (Figure 2). The 44 companies included then have been reduced to 40 companies because of consolidation through mergers and acquisitions. Another evident difference between these two periods is that the companies have significantly reduced production expenses since 2014, ultimately contributing to higher profitability despite the decline in revenues. Median company production expenses declined from $13.97/BOE in the third quarter of 2014 to $9.87/BOE in the third quarter of 2018. In fact, the median company's production expenses in the third quarter of 2014 would have been in the 75th percentile of production expenses in the third quarter of 2018, highlighting a broad reduction in production expenses among U.S. oil producers.
In contrast to the different operating environments of the two periods, measures of leverage (debt) and liquidity (ability to pay short-term liabilities quickly) do not appear to have significantly changed between 2014 and 2018. After the oil price decline of 2014, many companies restructured their balance sheets through debt consolidation, asset impairments, and asset sales. In the third quarters of 2014 and 2018, nearly all of the companies had long-term debt-to-asset ratios of less than 50%, meaning most of their assets were financed by the owners of the companies (Figure 3). Although no defined standard for an appropriate long-term debt-to-asset ratio for oil and natural gas production companies exists, the financial risk of inability to repay loans typically increases as the ratio increases. Alternatively, a ratio that is too low can indicate an inefficient use of resources available for investment.
Even though measures of leverage between the two periods are comparable, this group of U.S. oil producers has slightly different measures of liquidity in 2018 compared with 2014. In the third quarter of 2018, 80% of the companies had a ratio of cash assets to short-term liabilities of less than 40%, compared with 66% of companies with this ratio as of the third quarter of 2014. Similar to leverage ratios, no standard ratio is considered adequate, but a higher ratio indicates that a company has more ability to weather financial downturns.
An important caveat with comparative analysis of oil companies in two different periods is the survivor bias inherent in company selection. In this case, the U.S. Energy Information Administration (EIA) cannot assess a company's financial position in 2018 if the company did not survive the 2014 price decline, either because the company restructured from bankruptcy, delisted from a public securities exchange, or closed entirely. Companies that survived the 2014 price decline may provide a more positive picture of the overall financial position of the oil industry in 2018. However, this possible bias could be small because many of the same companies reported in both periods.
As discussed recently in EIA's Short-Term Energy Outlook and previous editions of This Week in Petroleum, price volatility and uncertainty remain high. The recent decision for countries inside and outside the Organization of the Petroleum Exporting Countries (OPEC) to reduce production levels could stabilize prices, but other supply factors or lower-than-expected demand could put further downward pressure on oil prices.
U.S. average regular gasoline and diesel prices decrease
The U.S. average regular gasoline retail price decreased more than 5 cents from last week to $2.37 per gallon on December 17, 2018, down more than 8 cents per gallon from the same time last year. Rocky Mountain prices fell 8 cents to $2.58 per gallon, Midwest prices decreased nearly 8 cents to $2.14 per gallon, West Coast prices fell nearly 6 cents to $3.11 per gallon, Gulf Coast prices fell more than 4 cents to $2.03 per gallon, and East Coast prices decreased more than 3 cents to $2.35 per gallon.
The U.S. average diesel fuel price decreased 4 cents from last week to $3.12 per gallon on December 17, 2018, 22 cents per gallon higher than a year ago. Rocky Mountain prices fell more than 6 cents to $3.18 per gallon, West Coast and Midwest prices each decreased nearly 5 cents to $3.60 per gallon and $3.02 per gallon, respectively, Gulf Coast prices decreased more than 3 cents to $2.90 per gallon, and East Coast prices fell nearly 3 cents to $3.17 per gallon.
Propane/propylene inventories decline
U.S. propane/propylene stocks decreased by 3.3 million barrels last week to 73.2 million barrels as of December 14, 2018, 5.6 million barrels (7.1%) lower than the five-year (2013–2017) average inventory level for this same time of year. Midwest inventories decreased by 2.5 million barrels, Gulf Coast and East Coast inventories each decreased by 0.4 million barrels, and Rocky Mountain/West Coast inventories decreased slightly, remaining virtually unchanged. Propylene non-fuel-use inventories represented 6.4% of total propane/propylene inventories.
Residential heating oil prices decrease slightly, propane prices flat
As of December 17, 2018, residential heating oil prices averaged almost $3.19 per gallon, down 1 cent per gallon from last week's price but nearly 30 cents per gallon higher than last year's price at this time. The average wholesale heating oil price for this week averaged $1.96 per gallon, over 3 cents per gallon less than last week and nearly 4 cents per gallon lower than a year ago.
Residential propane prices averaged $2.44 per gallon, less than 1 cent per gallon higher than last week but 4 cents per gallon lower than a year ago. Wholesale propane prices averaged nearly $0.86 per gallon, almost 6 cents per gallon less than last week and nearly 18 cents per gallon lower than a year ago.
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Headline crude prices for the week beginning 23 March 2020 – Brent: US$27/b; WTI: US$23/b
Headlines of the week
Crude oil prices have fallen significantly since the beginning of 2020, largely driven by the economic contraction caused by the 2019 novel coronavirus disease (COVID19) and a sudden increase in crude oil supply following the suspension of agreed production cuts among the Organization of the Petroleum Exporting Countries (OPEC) and partner countries. With falling demand and increasing supply, the front-month price of the U.S. benchmark crude oil West Texas Intermediate (WTI) fell from a year-to-date high closing price of $63.27 per barrel (b) on January 6 to a year-to-date low of $20.37/b on March 18 (Figure 1), the lowest nominal crude oil price since February 2002.
WTI crude oil prices have also fallen significantly along the futures curve, which charts monthly price settlements for WTI crude oil delivery over the next several years. For example, the WTI price for December 2020 delivery declined from $56.90/b on January 2, 2020, to $32.21/b as of March 24. In addition to the sharp price decline, the shape of the futures curve has shifted from backwardation—when near-term futures prices are higher than longer-dated ones—to contango, when near-term futures prices are lower than longer-dated ones. The WTI 1st-13th spread (the difference between the WTI price in the nearest month and the price for WTI 13 months away) settled at -$10.34/b on March 18, the lowest since February 2016, exhibiting high contango. The shift from backwardation to contango reflects the significant increase in petroleum inventories. In its March 2020 Short-Term Energy Outlook (STEO), released on March 11, 2020, the U.S. Energy Information Administration (EIA) forecast that Organization for Economic Cooperation and Development (OECD) commercial petroleum inventories will rise to 2.9 billion barrels in March, an increase of 20 million barrels over the previous month and 68 million barrels over March 2019 (Figure 2). Since the release of the March STEO, changes in various oil market and macroeconomic indicators suggest that inventory builds are likely to be even greater than EIA’s March forecast.
Significant price volatility has accompanied both price declines and price increases. Since 1999, 69% of the time, daily WTI crude oil prices increased or decreased by less than 2% relative to the previous trading day. Daily oil price changes during March 2020 have exceeded 2% 13 times (76% of the month’s traded days) as of March 24. For example, the 10.1% decline on March 6 after the OPEC meeting was larger than 99.8% of the daily percentage price decreases since 1999. The 24.6% decline on March 9 and the 24.4% decline on March 18 were the largest and second largest percent declines, respectively, since at least 1999 (Figure 3).
On March 10, a series of government announcements indicated that emergency fiscal and monetary policy were likely to be forthcoming in various countries, which contributed to a 10.4% increase in the WTI price, the 12th-largest daily increase since 1999. During other highly volatile time periods, such as the 2008 financial crisis, both large price increases and decreases occurred in quick succession. During the 2008 financial crisis, the largest single-day increase—a 17.8% rise on September 22, 2008—was followed the next day by the largest single-day decrease, a 12.0% fall on September 23, 2008.
Market price volatility during the first quarter of 2020 has not been limited to oil markets (Figure 4). The recent volatility in oil markets has also coincided with increased volatility in equity markets because the products refined from crude oil are used in many parts of the economy and because the COVID-19-related economic slowdown affects a broad array of economic activities. This can be measured through implied volatility—an estimate of a security’s expected range of near-term price changes—which can be calculated using price movements of financial options and measured by the VIX index for the Standard and Poor’s (S&P) 500 index and the OVX index for WTI prices. Implied volatility for both the S&P 500 index and WTI are higher than the levels seen during the 2008 financial crisis, which peaked on November 20, 2008, at 80.9 and on December 11, 2008, at 100.4, respectively, compared with 61.7 for the VIX and 170.9 for the OVX as of March 24.
Comparing implied volatility for the S&P 500 index with WTI’s suggests that although recent volatility is not limited to oil markets, oil markets are likely more volatile than equity markets at this point. The oil market’s relative volatility is not, however, in and of itself unusual. Oil markets are almost always more volatile than equity markets because crude oil demand is price inelastic—whereby price changes have relatively little effect on the quantity of crude oil demanded—and because of the relative diversity of the companies constituting the S&P 500 index. But recent oil market volatility is still historically high, even in comparison to the volatility of the larger equity market. As denoted by the red line in the bottom of Figure 4, the difference between the OVX and VIX reached an all-time high of 124.1 on March 23, compared with an average difference of 16.8 between May 2007 (the date the OVX was launched) and March 24, 2020.
Markets currently appear to expect continued and increasing market volatility, and, by extension, increasing uncertainty in the pricing of crude oil. Oil’s current level of implied volatility—a forward-looking measure for the next 30 days—is also high relative to its historical, or realized, volatility. Historical volatility can influence the market’s expectations for future price uncertainty, which contributes to higher implied volatility. Some of this difference is a structural part of the market, and implied volatility typically exceeds historical volatility as sellers of options demand a volatility risk premium to compensate them for the risk of holding a volatile security. But as the yellow line in Figure 4 shows, the current implied volatility of WTI prices is still higher than normal. The difference between implied and historical volatility reached an all-time high of 44.7 on March 20, compared with an average difference of 2.3 between 2007 and March 2020. This trend could suggest that options (prices for which increase with volatility) are relatively expensive and, by extension, that demand for financial instruments to limit oil price exposure are relatively elevated.
Increased price correlation among several asset classes also suggests that similar economic factors are driving prices in a variety of markets. For example, both the correlation between changes in the price of WTI and changes in the S&P 500 and the correlation between WTI and other non-energy commodities (as measured by the S&P Commodity Index (GSCI)) increased significantly in March. Typically, when correlations between WTI and other asset classes increase, it suggests that expectations of future economic growth—rather than issues specific to crude oil markets— tend to be the primary drivers of price formation. In this case, price declines for oil, equities, and non-energy commodities all indicate that concerns over global economic growth are likely the primary force driving price formation (Figure 5).
U.S. average regular gasoline and diesel prices fall
The U.S. average regular gasoline retail price fell nearly 13 cents from the previous week to $2.12 per gallon on March 23, 50 cents lower than a year ago. The Midwest price fell more than 16 cents to $1.87 per gallon, the West Coast price fell nearly 15 cents to $2.88 per gallon, the East Coast and Gulf Coast prices each fell nearly 11 cents to $2.08 per gallon and $1.86 per gallon, respectively, and the Rocky Mountain price declined more than 8 cents to $2.24 per gallon.
The U.S. average diesel fuel price fell more than 7 cents from the previous week to $2.66 per gallon on March 23, 42 cents lower than a year ago. The Midwest price fell more than 9 cents to $2.50 per gallon, the West Coast price fell more than 7 cents to $3.25 per gallon, the East Coast and Gulf Coast prices each fell nearly 7 cents to $2.72 per gallon and $2.44 per gallon, respectively, and the Rocky Mountain price fell more than 6 cents to $2.68 per gallon.
Propane/propylene inventories decline
U.S. propane/propylene stocks decreased by 1.8 million barrels last week to 64.9 million barrels as of March 20, 2020, 15.5 million barrels (31.3%) greater than the five-year (2015-19) average inventory levels for this same time of year. Gulf Coast inventories decreased by 1.3 million barrels, East Coast inventories decreased by 0.3 million barrels, and Rocky Mountain/West Coast inventories decrease by 0.2 million barrels. Midwest inventories increased by 0.1 million barrels. Propylene non-fuel-use inventories represented 8.5% of total propane/propylene inventories.
Residential heating fuel prices decrease
As of March 23, 2020, residential heating oil prices averaged $2.45 per gallon, almost 15 cents per gallon below last week’s price and nearly 77 cents per gallon lower than last year’s price at this time. Wholesale heating oil prices averaged more than $1.11 per gallon, almost 14 cents per gallon below last week’s price and 98 cents per gallon lower than a year ago.
Residential propane prices averaged more than $1.91 per gallon, nearly 2 cents per gallon below last week’s price and almost 49 cents per gallon below last year’s price. Wholesale propane prices averaged more than $0.42 per gallon, more than 7 cents per gallon lower than last week’s price and almost 36 cents per gallon below last year’s price.
Headline crude prices for the week beginning 16 March 2020 – Brent: US$30/b; WTI: US$28/b
Headlines of the week