by Gaurav Pallod
A perfect storm of weak demand, unbridled production by warring producers, and exhaustion of storage capacity drove WTI crude to a negative price for the first time in history, closing at -$37.63/bbl.
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Crude stockpiles at the storage centers in Oklahoma were reaching capacity, and many major pipeline operators are requiring shippers to prove their crude has a destination so that it will not strand the lines.
Solutions being considered in Washington to include utilizing the U.S. Strategic Petroleum Reserve as temporary storage and deploying financial incentives to keep operators from producing and adding to the glut.
But, Why Now?
In recent years, the Saudi-led Organization of the Petroleum Exporting Countries and other nations, like Russia, have coordinated production cuts, intended to prop up oil prices.
They were working together to increase prices as U.S. private oil producers pumped more oil into the market. But in early March, Saudi Arabia and Russia had a price war. Meanwhile, U.S. private oil producers continued to pump even as prices fell.
U.S. production hit a record of 13.1 million barrels/day in late February and plateaued through March. U.S. companies were reluctant to slow down, having borrowed heavily in recent years to drill wells, build pipelines, and maintain fleets of expensive machinery. With billions of dollars of debt coming due, they couldn't afford to stop pumping, but by late March, oil prices had fallen by more than a half.
In April, Saudi Arabia and Russia where the government budgets were heavily dependent on oil sales, joint forces again. They convened a group of 23 oil-producing nations who agreed to once again restrict output and support prices. They agreed to reduce their collective output by about 10 million barrels a day. The agreement start date of May 1 has encouraged parties like Saudi Arabia to pump as fast as possible before the deal takes effect.
However, the global oil market is undoubtedly weak—driven by the utter demand collapse due to worldwide lockdowns as a result of COVID-19- and has produced a market so oversupplied it has triggered a price collapse it appears even production cuts by OPEC+ have so far been powerless to halt. Some analysts believe demand has dropped by 30 million barrels per day, meaning that the output could continue to outstrip demand. Meanwhile, Jet fuel consumption has also fallen by more than 70%.
That oversupply is so extreme it has triggered a storage crisis—making storage space more valuable than the oil itself. That is already causing the halting of drilling and refining because there is nowhere for the oil to go.
Oil can’t be dumped due to government regulations. So, May futures contract for WTI closed on Monday, 20th April at -$37.63. So crude oil producers were willing to pay someone to take the product off their hands.
The May WTI contract plunged as the contract expired on Tuesday when the owner of the contract is technically supposed to take delivery of the crude, and the problem began: The oil storage terminal in Cushing, Oklahoma is nearly full, given the ample US production and refineries slowing their output as gasoline demand drops, and the pipeline capacity to get it out is very limited.
The crash also called attention to the fact that most oil trading is in futures, not physical barrels of oil. With such a contract the delivery of the commodity is carried out at a later date.
Futures trading helps market participants by allowing them to lock into prices, either to sell or buy, but also allows for speculation.
Those who speculate on oil futures and don't want to hold it have to get rid of the May contract before it expires on Tuesday, 21st April causing the price of the contract to have a freefall.
But while a tweet or an OPEC statement has made prices jump before, the question now is whether the oil markets are even listening.