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Whither Oil Prices and Inflation

Scott Anderson
Chief Economist

At the start of the year expectations were for flat, but stable oil prices in 2020.

But, the reality has been decidedly different with spot West Texas Intermediate oil prices plunging from $61.46 at the start of the year to just $16.50 on April 23, a decline of over 70.0%. WTI oil prices are now at their lowest level since 1999.

The COVID-19 pandemic has decimated global demand for oil and gasoline, while OPEC+ has been unable to cut oil supply enough to rebalance the oil market. As a result, global oil storage capacity is running low, and prices for temporarily storing oil at sea in oil tankers is skyrocketing – front month WTI futures prices actually went sharply negative for a time. Panicked investors were basically paying buyers to take their physical oil.

There Will Be Unwelcome Consequences

The sharp and unexpected drop in crude oil prices in March and April will create a significant decline in oil drilling and other economic activity in states like Texas, Oklahoma, Louisiana, Colorado, Wyoming and North Dakota in the months to come. These states are heavily dependent and on the oil industry for their overall economic performance. Already reeling from the COVID-19 pandemic, these states will be hit with a one-two punch to employment and state tax revenues.

U.S. shale oil producers and their employees will be devastated by lower oil prices too. Shale producers have much higher production costs than OPEC producers and need oil prices in the low $40s per barrel to cover costs according to Enverus, an energy consulting firm.

Oil prices at these low levels will force many more shale producers to slash drilling and well completions and lay off employees to maintain cash flow. Moreover, shale producers assumed too much debt during the good times and may not be able to survive the steep drop in oil prices.

U.S. oilfield service providers are also likely to suffer from lower prices as shale producers have asked for service cost cuts of at least 25.0% after budgeting based on crude prices between $55 and $65 per barrel. Service providers have responded by furloughing and laying off employees, with oil giant Halliburton furloughing 3,500 employees in late March. Defaults, bankruptcies and consolidation in the U.S. oil industry are next on the agenda.

Not Many Winners from Lower Oil Prices This Time

Most consumers would normally benefit from lower oil prices once they translate into lower prices at the pump. The national average gas price is expected to fall from $2.33 in March to $1.56 in May and remain under $2.00 through the end of the year, according to the latest forecasts from the Energy Information Administration.

Lower gas prices would normally allow consumers to increase discretionary spending, but with shelter-at-home orders still very much in place in much of the country, and job losses totaling over 26 million over the past five weeks, that is not likely to occur this time.

Consumer Price Deflation on the Horizon? Maybe

The International Energy Agency expects worldwide oil demand to decline by 90,000 barrels a day in 2020 with the U.S. and global economies in recession. The actual drop in daily global oil demand may end up being even greater.

We forecast U.S. real GDP will contract by an astounding 6.3% this year with the global economy likely to shrink by 3.2%. A second COVID pandemic wave across the U.S. and Europe in the fall and winter would cut these U.S. and global growth forecasts even more.

Our current forecast is that WTI crude oil prices will average $28.60 this year and $34.00 in 2021 – still well below break-even for many shale oil producers. This will accelerate deflationary pressures on consumer and producer prices that are already surfacing as global demand weakens. U.S. CPI inflation Q4/Q4 is projected to be zero in 2020 – lower than 2015’s meager 0.4% gain.

To learn more, check out this week’s U.S. Outlook.

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