On 20 April 2020, West Texas Intermediate (WTI) futures experienced unprecedented developments. WTI contract prices for delivery in May dropped to below zero. One may ask it would be the same for June. In this specific period, negative prices were driven by an unusual circumstance due to an expiring futures contract. However, unless the oil demand situation changes quickly, the US could face single digit or even negative oil prices throughout the summer.
What happened in future markets on April 20?
What happened in April was that there appeared to be no buyers for the May contract, which expired on April 21. Prices collapsed from about $18/barrel on April 17 to -$37.63/barrel because traders could not find a refiner or storage tank with capacity to take delivery. If you have 100 sellers and only a handful of buyers, prices will fall. In energy markets, where physical systems cannot be easily shut off, prices can go negative to incentivize suppliers to cease production. In this case, traders were paying what few demand sources there were to take their oil contract.
Why did the prices fall to below zero for May delivery?
NYMEX crude oil futures are the primary price for US oil. A NYMEX futures contract provides a price per barrel for 1,000 barrels of oil to be delivered to a massive oil logistics hub in Cushing, Oklahoma, over the course of a specific month. Contracts are sold by oil producers to lock-in prices for future production, bought by refiners and storage entities to lock in prices for purchases, and also sold and bought by oil traders to mediate prices between buyers and sellers, providing market liquidity. When you hold a contract at its expiration, you have an obligation to make that delivery to the buyer at Cushing. Normally, when contracts expire, traders sell their contracts to demand sources that can take delivery, like refiners or oil storage, with minimal impacts on prices.
In practical terms, the collapse in the May contract does not mean that oil is free or that you personally can be paid to take oil. Only a small number of May contracts actually traded at prices below zero. Most oil set to be delivered to Cushing next month settled at prices well above $20/barrel. Prices for June and July contracts remain above $20/barrel, as do prices for international oil deliveries. Nevertheless, the signs for oil markets ahead are, to say the least, worrisome.
With such large declines in demand, the amount of oil in storage has been growing rapidly in the U.S. and around the world. Energy markets are priced based on location. The hub in Cushing, Oklahoma, (where storage tanks are owned by various midstream and pipeline companies) features the greatest amount of commercial oil storage in the U.S., with an estimated ability to store 76.1 million barrels of oil. Last week, Cushing reached 55 million barrels in storage and is growing by almost 1 million barrels per day. At its current rate, they are expected to be full by mid-May. U.S. oil inventories beyond Cushing have grown by 50 million barrels in the last month.
Will WTI prices become negative again for June delivery?
If traders were unable to find storage for oil deliveries next month – even at unfathomable negative prices – there are likely to be severe storage limitations for June and beyond. Unless oil demand returns quickly, prices are likely to collapse again in order to drive oil producers to turn off production. Called shut-ins, reducing production can be costly and can damage oil wells. Local economies in oil-producing states are already seeing major job losses and decreases in the tax base, and may be in for even more.
Why some crude oil grades in the US and Canada are single-digit or negative?
Production much greater than demand could overwhelm oil storage globally and cause oil prices to reach unprecedented low levels throughout the world. Already, Canada is seeing oil prices consistently near or below $0/barrel. Many oil-exporting nations depend on oil exports to drive their economy and are likely to suffer economic upheaval.
It started with the futures’ contracts for WTI – oil to be delivered in a few months at today’s price. It lost US $6 a barrel, fetching US $11.66, but ended the day at -US $37 as holders of future contracts tried to dump their contracts before oil is actually delivered with nowhere to store it.
But Alberta oil, primarily derived from oil sands (referred to as Western Select), typically sells at US $10 to US $15 below the price of WTI, because it has to be extracted from deep rocky terrain. That makes it harder to refine, and it also has to be transported thousands of kilometers to American refineries.
And so Alberta oil prices have become negative in the sense that the benchmark price is now lower than the cost of its production, transport and storage.
This state of affairs cannot be expected to last for long. Producers, in the short term, may accept prices below their variable cost as long as they are able to pay some of the costs they will incur even if oil production shuts down.
As time passes, more and more rigs will stop operating (technically, a few will be kept operational in order to avoid being compromised) and a new balance between supply and demand will be established at prices that exceed total average cost. But this doesn’t bode well for either Alberta or the United States.
Will June suffer the same fate as the May contract in coming weeks? After all, storage is likely to be even more tight in the weeks ahead. The June contract was under heavy pressure Tuesday morning, falling around 21% to trade a little bit above US $16 a barrel, while May remained in negative territory.
Long-term market bulls argue that the steepness of the contango curve – the December 2020 contract CLZ20, 4.01% is trading above $32 a barrel – seems to indicate optimism for an eventual recovery as economies move past the pandemic shutdowns, and demand for crude revives in the second half of the year.