NEW YORK (Reuters) – U.S. refiners and other buyers of crude oil are reworking some of their supply contracts to guarantee volumes after many were cut off unexpectedly when a price collapse this spring led drillers to curtail production, sources said.
FILE PHOTO: A pump jack is seen at sunset near Midland, Texas, U.S., on May 3, 2017. Picture taken May 3, 2017. REUTERS/Ernest Scheyder/File Photo
The effort reflects concern in the refining industry about the possibility of another drop in oil prices as world markets continue to reel from the economic fallout of the coronavirus outbreak.
Sellers will likely be forced to agree to the terms as buyers remain scarce in the oil market, traders and analysts said.U.S. oil prices crashed into negative territory for the first time in history in April as the pandemic crushed energy demand, prompting oil producers to shut in about 2 million barrels per day (bpd) of production, or nearly a fifth of the country’s output.
Normally a drop in prices is good for refiners, but only when they can get their hands on the cheap supply.Typically, physical crude sales agreements between buyers and suppliers at the wellhead specify a price differential to a floating benchmark that can rise or fall with the markets, but do not specify volumes that must be sold, allowing suppliers to hold back sales when the price is too low.
“Now they are trying to install volume thresholds into the lease contracts,” one of the sources, who works at an oil producer company, told Reuters.The seller typically has little clout in a lease agreement, said Sandy Fielden, analyst at Morningstar.
“Adding a volume clause helps guarantee supplies for buyers, but to make such a change now is acting after the horse has bolted and the only producers who can meet the volume requirements are those with enough tankage at the wellhead to give them that flexibility.”
Some producers are now also selling at discounted rates after failing to deliver in previous months when they shut wells, in order to avoid legal disputes with buyers, some of the sources said.
“You’re losing the price benefit now, but refiners are mad,” another source at a shale producer said. “There are a bunch of lease contracts that are going to read differently.”
Some U.S. oil producers declared force majeure, an emergency clause typically set aside for acts of god or wars that provides some legal cover to breach contracts. But such declarations have drawn criticism from refining groups.