Implications of Negative Oil

Updated: Apr 22, 2020

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OG BRIEF #10

April 21, 2020

As so many people continue to stay put during COVID-19, the oil market is facing it's own unprecedented crisis: Negative oil.


Yesterday WTI prices cratered in a bizarre move that seasoned traders say was unlike anything ever seen in markets. "I didn't even know a futures commodity could go negative," says one trader. Technically commodities like agriculture can go to zero, due to rotting and limited shelf-life, but we usually don't see that in market prices. In energy markets, products have the benefit of storage and almost infinite shelf-life.


"Clearly yesterday was historic and unprecedented. We’ve never seen oil go negative and frankly go so far negative down to -$40. But I think it’s also important to take a moment to recognize who really suffered yesterday. I believe the hedgers and the speculators are the ones that took a bath yesterday and those in the Oil Patch that actually were able to provide physical delivery and had storage options probably made a good bit of money or made some good bets yesterday. Who is to say what the biggest drivers are but it’s certainly devastating for Houston and devastating for the country" said Regina Mayor Global Head of Energy at KPMG.


Crude oil for May delivery saw a knife-fall drop in a matter of hours on Monday.


Unlike the stock market exchanges, the futures market exchange, known as the Chicago Mercantile Exchange, "is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery set at a specified time in the future. These types of contracts fall into the category of derivatives. A counterpart to the futures market is the spot market, where trades occur immediately after a transaction agreement has been made, rather than at a predetermined time in the future" according to Wikipedia.


One futures contract is for delivery of 1,000 barrels of oil. Each penny move in the price of crude is $10 per tick to the paper barrel trader (so, a dollar move in the price of crude is $1,000 profit. Think about that...) Simply put, David Ramsden-Wood comments that "a ‘contract’ is made when a producer says to their marketer: “I have 1,000 bbls to deliver in May.’ The marketer goes and sells those barrels to a refinery or other end user and thus, creates a market. But, like all things in a capitalist world, there are speculators and traders that want to intervene and participate in the market. They don’t want the physical barrels but they want to buy and sell paper barrels to capture value where they see a disconnect."


Today the front-month (May) contract expired. After today, if you are left holding the May contract, you would be contractually obligated to accept 1,000 barrels.

Some argue we are not in a normal free market right now. But all markets act to accommodate price, incentivizing buyers and sellers to take a position. Negative oil means there are no buyers, and in order to sell you must pay the buyer. In the physical market, this could only be true if storage was near full or there were literally no buyers stepping up. Some analysts say we could see near-zero or negative prices once again. The storage tanks in Cushing are expected to be full in coming weeks. Will we see negative oil again? I hope not, but I'm reminded that this demand shock is unlike anything seen before, and can take prices lower than what may seem logical.


US Rig Count



"On April 15, the WTI front-month contract settled at an 18-year low of $19.87/bbl. Despite OPEC+ agreeing to cut production by 9.7 MMbo/d beginning May 1, shrinking demand and growing storage inventories point to a growing glut of oil. During Q1, global consumption of petroleum and liquid fuels was at 94.4 MMbbl/d, down by 5.6 MMbbl/d from the same period in 2019, according to the US Energy Information Administration. For the full year, the agency forecasts a 5.2 MMbbl/d contraction YOY in such demand. By Q3, the EIA believes the US will once again become a net importer of oil as its D&C activity falls and producers shut in production. Significant curtailments are in the works. For example, ConocoPhillips announced April 16 that it would curtail 125,000 bo/d in the Lower 48 beginning in May, in addition to 100,000 bo/d in Canada. US production in 2020 is forecast to fall by 500,000 bo/d compared to 2019 and drop by another 700,000 bo/d in 2021, according to the EIA’s April Short-Term Energy Outlook. The number of rigs running in the US as of April 15 has fallen by 33% in the last month, according to Enverus. The active rig count is down 48% YOY."


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