Apr 26, 2020
Has the Era of Negative Oil Prices Arrived?
On Monday night, the price of US WTI crude oil fell to a negative value.
Due to the outbreak of COVID-19, crude oil prices have plummeted to below $20 for the first time since 1998, and have fallen from $54 a barrel, where crude traded in mid-February.
Disagreements between OPEC and other oil-producing countries have kept a strong and coordinated effort to reduce output from materializing. Some have speculated that both Saudia Arabia and Russia increased production over the last few months, despite announcing some cuts two weeks ago.
Furthermore, several oil supply contracts expired earlier this week, but the oil depot is still full; there are little to no customers willing to take delivery of physical crude.
While this may sound unreasonable, oil prices are based on supply and demand.
As the outbreak caused the global economy to stagnate, companies ordered less oil, airlines grounded their aircraft, and consumers stayed home.
Therefore, recently produced oil can only flow into existing oil storage facilities. However, as these facilities become increasingly saturated, the storage costs rise, and investors want to escape from the contract.
This raises another issue: why have only the May contracts become negative?
The U.S. Energy Information Administration announced last week that U.S. crude oil inventories increased by more than 19 million barrels, an increase for 12 consecutive weeks. That means traders will soon have insufficient space to store crude oil.
If traders do not close their long position on the May contracts, they will receive oil with no storage options.
In other words, the May contract became a hot potato for traders.
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Bjarne Schieldrop, the chief commodities analyst at SEB, told CNBC that “we have a big problem with the storage of oil right now.”
If the demand has caused crude prices to plummet, then why have the West Texas Intermediate (WTI) crude oil futures become negative, while Brent crude oil futures have not?
WTI crude oil has one-dimensional storage, the oil pipelines end at the world’s largest oil storage facility in Cushing, Oklahoma, which is currently full. Despite 15 storage terminals with 90 million gallons of storage capacity that equates to 13% of US crude storage, the facility had almost entirely run out of storage space. Current storage costs are around $10 per barrel, and prices may continue to rise.
Conversely, Brent crude oil has more options for delivery, which alleviates some of the storage burdens. Cushing, Oklahoma is hundreds of miles from the nearest point vs. North Sea Brent which is measured in the middle of the ocean. You could never have the type of physical bottleneck that occurred at Cushing. If the problem is not solved, oil storage facilities on land around the world could become full.
Most commodity traders believe that spot contracts usually converge to the spot price as these contracts approach expiration. Traders who only want to trade paper contracts will sell their May contracts and buy the June contracts instead.
However, the current spot price is particularly weak due to the lack of demand, which may be the cause of the significant spread between the May and June contracts. The June contracts traded near $20 per barrel on Monday when prices went negative. As long as there is a bottleneck of production mixed with a lack of market demand, prices will continue to be in trouble.
To support prices and replenish national reserves, President Trump announced that he would buy 75 million barrels of oil.
However, Trump’s rescue operation is a drop in the bucket, as the total purchase equals less than four days of US crude demand in 2019, according to the US Energy Information Administration.
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Written by Qian Pan, Edited by Jack Argiro, Gihyen Eom, Michael Ding & Alexander Fleiss
