Oil for Less Than Nothing? Here’s How That Happened

(Bloomberg) -- April 20, 2020 will go down in oil-market history as the day when the U.S. benchmark price for crude dropped below zero for the first time -- and then kept falling. In a massive and unprecedented swing, the future contracts for May delivery of West Texas Intermediate tumbled to minus $37.63 a barrel. The jaw-dropping development was in no small measure down to an extreme glitch in the way oil futures operate. But it also revealed a fundamental truth about the oil market in the age of coronavirus and the aftermath of a price war: The world’s most important commodity is quickly losing all value as chronic oversupply overwhelms the world’s crude tanks, pipelines and supertankers.

1. Why would anyone pay to sell their oil?

For some producers, it may be cheaper in the long run than closing down production or finding a place to store the supply bubbling out of the ground. Many worry that shutting their wells might damage them permanently, rendering them uneconomical in the future. Then there are the traders who buy oil futures contracts as a way of betting on price movements who have no intention of taking delivery of barrels. They can get caught by sharp price drops and face the choice of finding storage or selling at a loss. And the escalating glut of oil has made storage space scarce, and increasingly expensive.

2. Where did the glut come from?

Either the pandemic or the price war alone would have rocked energy markets. Together, they have turned them upside down. As the virus started to spread around the globe, it began eating away at oil demand. But just as countries like Italy showed what kind of damage a national lockdown could do economically, Saudi Arabia and Russia, the world’s biggest oil producers, escalated the price war. A pact that had restrained production collapsed and both countries opened their taps to the fullest, releasing record volumes of crude into the market.

3. Wasn’t there a deal on that?

Yes, one worked out by OPEC, Russia, the U.S. and the Group of 20 countries. But its call for an overall production cut of roughly 10% proved to be too little, too late. Prices initially turned negative just in obscure corners of the U.S. market such as Wyoming, where storage options are few. Then major hubs began to register negative prices for small streams of selected crudes. And on April 20, prices fell sharply below zero on the NYMEX exchange, which is owned by CME, the world’s largest energy market.

4. What did futures contracts have to do with that?

The lowest prices came in trades in futures -- contracts in which a buyer locks in a purchase at a stated price at a stated time. Futures are a tool for users of oil to hedge against price swings, but also a means of speculation. The contracts run for a set period, and traders who don’t want to unwind their position or take delivery generally roll over their monthly contracts shortly before expiration to a month further in the future. Contracts for May delivery were due to expire on April 21, putting maximum pressure the day before on traders whose contracts were coming due. For them, selling at a steeply negative price was better than taking delivery of actual oil because nobody needs it and there are fewer and fewer places to put it.

5. What happened to other oil prices?

Brent futures, the benchmark for Europe in London, ended April 20 down sharply but still above $25 a barrel. The physical domestic crude market in the U.S. saw negative trades for grades like WTI in Midland, Mars Blend, Light and Heavy Louisiana Sweet crudes. Horrified by negative benchmark prices, some U.S. oil producers began offering crude at fixed prices for the first time since an oil rout in 2014-15. The WTI futures contract for June delivery changed hands at $20 a barrel on April 20 before falling further the next day -- highlighting the extent to which the rout was being caused by the massive glut in the market rather than just a technical quirk. Ever tightening constraints on storage capacity mean the June contract may also turn negative, according to one of the top trading houses.

6. What’s happening to storage?

Since the glut began to build and prices began to fall, storage facilities have been moving toward capacity. Crude stockpiles at Cushing in Oklahoma -- America’s key storage hub and delivery point of the WTI contract -- have jumped 48% to almost 55 million barrels since the end of February. The hub had working storage capacity of 76 million as of Sept. 30, according to the Energy Information Administration. The industry has been accumulating supply aboard ships, while contemplating other creative options such as storing oil in rail tanker cars. The Trump Administration, which is concerned about the possible ripple effect from oil bankruptcies, is eyeing a proposal, which is still in its infancy, to pay drillers to keep their oil in the ground temporarily. The idea would be to keep it off the market until prices recovered, giving the Treasury a healthy profit eventually while protecting producers from immediate losses.

7. What does this mean for consumers?

Nationwide, the average gasoline price is down more than $1 a gallon in the past year to $1.81. It’s fallen every day since late February. It’ll take a couple more weeks for the declines in futures prices to be reflected at the pump. And with taxes making up part of the price, there’s only so low they can go.

The Reference Shelf

• Peter Coy of Bloomberg Businessweek ties the oil market turmoil to “inelasticity.”
• The CME Group’s introduction to oil futures page.
• A QuickTake on the uneasy truce in the price war.
• What happened when Tracy Alloway of Bloomberg News tried to buy an actual barrel of crude oil.

©2020 Bloomberg L.P.