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Crude Oil Is Crashing Again: Here's Why

By Jason Hall - Sep 4, 2020 at 2:32PM

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The end of a weak summer-driving season, still-high inventories, and the threats of more foreign oil coming online are sending crude benchmarks lower.

The year 2020 has been a brutal year for the oil and gas industry, and the overhang of the coronavirus pandemic continues to weigh on it. Crude oil futures are falling sharply on Sept. 4. As of 1:07 p.m. EDT, Brent futures for November delivery were down 3.6% to $42.49, while West Texas Intermediate -- the key U.S. oil benchmark -- was down 4.2% to $39.64 for October delivery.

Today's sell-off, if it holds, will mark the third straight day of crude prices falling. It will also make this the worst week for oil prices since June. 

Fuel dispensers at a refueling station.

Image source: Getty Images.

Stalled demand recovery has held back a crude recovery

The week's sell-off started on Wednesday following the release of the U.S. Energy Information Administration's weekly supply report. While there were some positives, including a drawdown in commercial inventories that continues to weigh on the recovery, investors seemed more concerned by the relatively flat market supply and consumption data. 

Gasoline supply over the summer was expected to increase as more of the U.S. was able to return to normal activity, and consumers opting to avoid commercial air travel drove to vacation spots instead. The reality was different, with gasoline supply over the summer months increasing modestly but never breaking 9 million barrels per day. That's about 1 million barrels -- or close to 10% -- below 2019 levels and the five-year average. 

As a result, oil prices have been on a bit of a sideways grind since the beginning of June, with demand remaining sharply lower, and a massive supply glut preventing producers from being able to capitalize on even the modest increases in consumption:

WTI Crude Oil Spot Price Chart

WTI Crude Oil Spot Price data by YCharts

Multiple threats to crude prices going forward

Oil demand is much improved from the lows of April and May when many parts of the developed world were at a standstill under coronavirus lockdown orders. However, the virus -- both the health implications and the economic impact -- continues to weigh on global transportation, a reality that could last well into 2021. 

Moreover, industry heavyweights Saudi Arabia and Russia continue to cast a wide shadow, particularly over U.S. oil producers. Their capacity to quickly ramp up their output is likely to soak up much of the initial surge in demand post-COVID, while U.S. commercial inventories are still up by double-digits over the five-year average. 

China, a recent source of strong oil-demand growth, is going to have a smaller impact going forward. The country's refiners purchased massive quantities of oil when prices were well down, helping soak up some of the excess oil that was drowning the market in the second quarter.

According to reports, there are tens of millions of barrels of crude oil sitting on tankers at Chinese ports, waiting for weeks to be unloaded. The number of barrels of oil being shipped to the country was down more than 30% in August from the second quarter, as Chinese refiners return to more normal levels of buying. 

This is why, even with oil prices having recovered much of their losses and stabilized, oil stocks continue to lag. The Energy Select Sector SPDR ETF (XLE 0.52%), which tracks the energy stocks in the S&P 500 Index (^GSPC -0.12%), is still down more than 40% this year. 

U.S. oil stocks remain at risk

We have already seen dozens of oil companies go through bankruptcy in 2020, and that list is expected to grow longer as the year progresses. Many producers have been able to ride out the worst of the price and demand collapse with contracts and options signed before the crash, locking in higher prices for much of their production.

But as demand and prices stay low, and global heavyweights Russia and Saudi Arabia threaten to bring more oil back to the markets, the future is still bleak for many U.S. producers. Investors looking for a safer way to profit from the 2020 oil stock crash should consider logistics and refining specialists that have limited exposure to oil prices and can make money in the current demand environment. Here's my top pick

Jason Hall has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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