How Did We End Up With Negative Oil Prices?

Siamak Masnavi
  • 21 Apr 2020

Monday (20 April 2020) was a historic day for oil markets because this was the day when the price (per barrel) for the May 2020 futures contract of West Texas Intermediate (WTI) Crude went below zero for the first time ever. And WTI Crude was not alone -- the price of Canadian Western Select also reached subzero levels.

WTI Crude May 2020 on 21 Apr 2020.png

Around 14:00 EDT on April 20, the price for U.S. oil fell below zero for the first time in history, and by around 15:35 EDT, the price had reached -$38.08.

So, how did this happen?

In short, the near shutdown of the world economy due to the COVID-19 pandemic has resulted in a huge reduction in demand for oil. Falling demand usually leads to lower prices. 

In the case of the May 2020 futures contract, it expires at 14:30 EDT on 21 April 2020; this means that oil futures traders who are holding this contract must by this time either take physical delivery of the oil or find someone (a buyer) who is able to do so.

Taking physical delivery for one contract means picking up and storing 1000 barrels of oil, which is very difficult to do when you are dealing with a land-locked pickup location, which in the case of WTI Crude is Cushing, Oklahoma.

Cushing is "the largest crude oil storage hub in the USA and an important price settlement point for West Texas Intermediate (WTI) on the New York Mercantile Exchange (NYMEX)", and it is "the officially designated delivery point in the US where the physical delivery of the oil takes place, making it the most significant trading hub in crude oil in North America."

Although there are around 300 steel oil storage tanks in the tank farms around Cushing, as of yesterday, most of them of this storage space was either being used (since much of the U.S. has been in lockdown for the past few weeks) or it had been booked. 

This means that when the price of the May 2020 contract reached around -$38 per barrel, any futures traders who wanted to sell one of these contracts had to pay someone $38 per barrel to take the contract off their hands. 

According to a tweetstorm yesterday by Roger Diwan, who is a Vice President at London-based information provider IHS Markit Ltd, this is what we can expect for the other WTI Crude futures contracts:

  • "The contract roll and liquidity crunch that made the extreme sell-off today possible but it DOESN’T necessarily represent futures market conditions..."
  • "The June contract is not out of the woods either: today’s action indicate that physical oil markets at Cushing are not in good shape and that storage is getting very full."
  • "A decline of over 15% in the June contract price points to real worries that the physical stress will continue to reverberate, and will force a lot more production shutdowns during May than the ones announced so far."
  • "So today negative prices are the reflection of dire market conditions for producers, with the hope that demand restart before the middle of May and that the June contract does not face the same fate."

Earlier today, Kate Richard, who is the founder and CEO of energy-focused private equity firm Warwick Energy Group, told CNBC:

".. the contract that traded negative , which is the May contract, was 7% of the [trading] volumes yesterday...

"All that happened yesterday was about 108,000 long lots of the contract that had not closed out yet closed out...

"The reason that this contract traded negative is because some players went into yesterday long 108,000 contracts that were left to close out... and they were willing to pay rather to be paid to not physically receive crude next month.

"That's what happened.... The rest of the forward contracts for 2020 and probably for the first and maybe second half of 2021 are still too high."

According to data by MarketWatch, at press time (10:55 UTC on April 21), the June 2020 futures contract is trading at $16.97, down $3.46 (or 16.94%). 

As for the May 2020 contract, it is doing a lot better than yesterday's intraday low, but still trading below; currently, this contract is trading at -$6.00, up $31.63.

Many people in the cryptocurrency space who have long suffered from the criticism that the Bitcoin and other cryptocurrencies are much too volatile, found a negative price oil price highly amusing. One of those people was Barry Silbert, the founder and CEO of Digital Curency Group (DCG), who had this to say on Twitter:

 

Featured Image by "lalabell68" via Pixabay.com. Oil Price Chart Courtesy of MarketWatch.com.