Oil prices turn negative in the American markets!

For the first in over 100 years of trading, oil prices briefly traded in the negative on April 20, here is what you need to know about what exactly happened.

April 21, 2020 11:09 IST | India Infoline News Service
It was a scenario that most people saw for the first time in their lifetime and would probably never see such a scenario again. For the first in over 100 years of trading, oil prices briefly traded in the negative on April 20. Yes, it actually went as low as ($-37/bbl) in the US WTI futures market before returning into positive territory. If ever the Hollywood classic, “Honey I Shrunk the Kids” was remade with oil as its theme, then it would probably go something like, “Honey, I got paid to buy oil”. If you have any doubts, just look at the graphic below.
Data Source: Refinitiv

Before we jump to conclusions that traders would get paid to buy oil in the spot market, here is what you need to know about what exactly happened on April 20, 2020.

WTI May Futures and why it fell?

The sharp fall that we saw on April 20, 2020 specifically pertained to May futures contract on WTI Crude. Now, there are two popular crudes that are traded in the global market. The more popular North Sea Brent Crude is the benchmark used by the European, Middle Eastern, African and most Asian countries. Brent accounts for nearly 70% of world trade. West Texas Intermediate (WTI) Crude is more popular in the US, Canada, Mexico and parts of central and Latin America. The crash that we saw on April 20th essentially was the May WTI crude futures contract. The WTI June contract was still trading at around $21/bbl, while the more popular Brent Crude contracts were trading at above $26/bbl. The sharp fall in the May futures was because these contracts expire on April 21st and there was virtually nobody wanting to buy these futures contracts on oil as the whole of North and Central America was running out of storage space. That is what actually led to the anomalous pricing. But, it is also indicative of the pressure that oil is under.

Oil fall – The demand compression perspective

If there is something the COVID-19 pandemic has contributed to, it is a sharp compression in the demand for oil. As the BBC reported, the demand for oil is suddenly drying up at multiple levels. Flights have been grounded across the world, lockdowns have made cars and public transport services idle and refiners are reducing throughput. The demand for oil is likely to be lower by 29% in April. China has already reported 6.8% contraction in GDP in the March quarter and Germany and Japan have also hinted at contraction. The US is likely to feel the pinch of the lockdown most being the worst hit by the pandemic. With oil demand likely to fall by at least 30 million bpd, supply cuts are unlikely to make a difference.

Oil fall – Supply cuts may not really matter

OPEC and Russia along with other nations had agreed to cut oil output by up to 15 million bpd. However, this output cut is only likely to commence from May. As of April, both Russia and Saudi Arabia are continuing to flood the market with oil supply. The US shale has a much higher breakeven point but needs to keep churning oil just to pay its interest on loans. The 15 million bpd supply cut is a sort of best case scenario and even that is unlikely to have any impact if the oil demand falls by more than 30 million bpd.

Oil fall – Actually, the US is running out of storage space
Data Source: Refinitiv

The above chart shows widening spread between Brent Crude and WTI Crude, largely because Europe has a lot more storage space available compared to the US. If there is one critical reason that drove US WTI prices into negative zone, it is the US running out of storage space. Normally, when oil prices go really low, countries use the levels to add on to strategic reserves. The US had created the Strategic Petroleum Reserve after the Oil Shock of 1973. At one of its biggest facilities in Cushing, Oklahoma, the US is holding 675 million barrels and could easily add another 75 million barrels (as committed by Trump). But the challenge is that it can only handle 500,000 barrels per day, so it will take a long time to fill up and that puts limits on demand. But the real issue is that the US may be running out of storage space with most of its existing capacities across the US and Central America likely to run out of space by end of May 2020. That drove oil futures into negative territory.

What do negative oil prices really mean?

We may not see negative spot prices but year 2020 could be a landmark year for the future of oil. Analysts are already warning of record shale bankruptcies in the US. Global markets will remain under pressure because most indices are still oil dependent. The deep cut in WTI on 20th April was just a trailer to the bigger story of oil that is likely to follow.

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