The world could soon run out of space to store oil. That may plunge prices below zero

The world’s thirst for oil has evaporated.

Highways are empty. Planes are grounded. Factories are dark. The unprecedented collapse in oil demand has sent crude crashing to 18-year lows.

Supply, on the other hand, remains largely resilient amid a price war between Saudi Arabia and Russia. US producers don’t want to be the first to blink by turning off production.

That could mean a supply glut so epic that the world will soon run out of room to store all the unneeded barrels of oil.

“The market is starting to signal that not only is there no demand for this crude, eventually there could be nowhere for it to go,” said Jeff Wyll, senior energy analyst at Neuberger Berman.

In other words, storage facilities, refineries, terminals, ships and pipelines eventually could reach capacity – something that hasn’t happened since 1998, according to Goldman Sachs.

Pump jacks draw crude oil from the Long Beach Oil Field near homes in Signal Hill, California, on March 9, 2020. - Global stocks and oil prices rebounded on March 10, 2020 on hopes of US economic stimulus efforts as the coronavirus rages, one day after suffering their biggest losses in more than a decade. Trading is exceptionally volatile as investors attempt to get a grip on a rapidly changing news flow, with positive reports of progress in China on the virus clashing with a Saudi decision to increase oil output in an already over-supplied market. (Photo by David McNew/AFP/Getty Images)

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Distressed pricing in some corners of the oil market shows that investors are starting to price in therisk that might occur soon.

Although headline oil prices such as West Texas Intermediate and Brent are trading north of $20 a barrel, some regional prices have recently plunged into single-digit territory. That is especially true for landlocked grades of crude where access to storage is even trickier.

“Demand is falling so fast relative to supply that very soon many producers’ main issue is not going to be whether they can ensure operating profit but rather if they can find an outlet for their crude,” analysts at JBC Energy wrote in a report Tuesday.

One storage option: loading all that extra crude onto ships. JBC said about 20% of the global fleet of very large crude carriers (VLCCs) could become floating storage. But even that would not absorb the surplus.

In April, some 6 million barrels per day of “homeless crude” might literally have nowhere to go, JBC said, a figure that would rise to 7 million barrels per day in May.

Negative oil prices

This oil glut is creating a scenario where some obscure grades of oil already have actually dropped below zero. For instance, a Wyoming crude grade was recently bid at negative 19 cents a barrel, Bloomberg News reported last week.

Shrinking storage capacity means that oil producers in some cases have to pay someone just to take the barrels off their hands.

“The price is trying to go to a level to force companies to keep the oil in the ground. If it has to go negative to incentivize that behavior, then it will,” said Neuberger’s Wyll.

Brent, the global benchmark, is likely protected from this because it’s priced on an island in the North Sea where tank storage is accessible. But other grades of crude are located far from water.

WTI, however, is 500 miles from water. That’s why Goldman’s Currie said WTI, especially WTI Midland, and Canada’s Western Canadian Select “can go negative.”

Subzero oil prices are certainly bizarre, but there is some limited precedence in the energy market.

Last year, US natural gas prices in West Texas traded in negative territory for more than two weeks because there were not enough pipelines to carry the gas away, Reuters reported.

‘Mother of all market surpluses’

But even then, negative natural gas prices didn’t really discourage production. That’s because the West Texas natural gas was largely a byproduct of oil pumped from the Permian Basin. Oil companies were willing to take a loss on the natural gas to get what was then a valuable barrel of oil.

With the collapse in oil prices, oil has lost more than two-thirds of its value since the January peak.

Now, US oil companies are starting to make the painful decision of “shutting in” production, albeit reluctantly.

Physical constraints have forced at least 900,000 barrels per day of announced “shut-ins,” according to Goldman Sachs, which noted the true number is likely higher and “growing by the hour.”

Michael Wirth, chairman and chief executive officer of Chevron Corp., speaks during the World Gas Conference in Washington, D.C., U.S, on Tuesday, June 26, 2018. The 27th World Gas Conference, themed Fueling the Future, is held every three years in the country holding the Presidency of the International Gas Union (IGU). Photographer: Andrew Harrer/Bloomberg via Getty Images

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Rystad Energy said that the “mother of all oil market surpluses” will force large production shut-ins in April and May. Older, less productive oil wells will likely shut down first.

Even the strongest US oil companies say they’ll scale back spending and production. Chevron (CVX), for instance, announced plans last week to slash spending by 30% and lowered its output targets in the Permian by 20%.

Eventually, the industry could lose as much as 5 million barrels per day of oil supply capacity, Goldman Sachs said.

Will this set the stage for an oil shock?

Of course, the weak demand caused by the coronavirus pandemic won’t last forever.

Eventually, airlines will take to the air again and start buying jet fuel. American drivers will buy more gasoline as they get back to work.

But by that point the oil industry might not be producing as much oil as before because wells shut down. Today’s oil glut may suddenly turn into tomorrow’s oil scarcity, pushing prices “far above” $55 next year, Goldman Sachs commodities head Jeffrey Currie said.

“This will ultimately create an inflationary oil supply shock of historic proportions,” Currie wrote.